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In 2024, surveys such as Freddie Mac’s Primary Mortgage Market Survey® have shown that mortgage interest rates are continuing their year-over-year increase. This means that homebuyers may still be looking for ways to obtain lower interest rates and monthly payments.
Most people already know that good credit leads to better rates, but you can also secure lower monthly payments by buying down your mortgage interest rate.
Buying down your mortgage means paying more upfront to lower your interest rate. This can be a helpful way to handle the long-term expense of a mortgage, but it may not make sense in every scenario. Here’s what you need to know about the benefits and drawbacks of buying down your mortgage interest rate.
How do you buy down your mortgage interest rate?
You can buy down your mortgage interest rate by paying mortgage points (discount points) at closing. These points will be listed in your mortgage loan estimate and closing disclosure.
Think of a discount point as prepaid interest. When you purchase discount points, you get a lower rate for the duration of your mortgage or the first few years of payments, depending on how your buydown is structured.
How discount points work
While the cost of a point is 1% of your total loan amount, each point you purchase lowers your interest rate by an amount decided by the lender, the type of mortgage, and the current condition of the housing market.
For example, let’s say your lender has calculated that a discount point equals a 0.25% reduction in your mortgage’s interest rate. So, if you’ve borrowed $500,000 at an interest of 5% and purchased one mortgage point for $5,000, your lender will reduce your interest rate to 4.75%. If you pay $10,000 for two mortgage points, your interest rate will drop to 4.5%.
Different ways to buy down your mortgage
While purchasing discount points will lead to lower monthly payments, lenders may structure your mortgage buydown in a few different ways. Here’s what to know about each one.
- Permanent rate reduction: With a permanent reduction, purchasing discount points leads to lower monthly payments for the entire life of the loan.
- 1-0 Buydown: This is a temporary one-year buydown in which buyers pay 1% less in interest during the first year of the mortgage, after which they pay the normal rate.
- 2-1 Buydown: In this structure, buyers pay a reduced rate for the first two years of their mortgage. That’s 2% less in the first year and 1% less in the second. From the third year, the normal rate applies.
- 3-2-1 Buydown: Buyers can expect their interest rate to be reduced by 3% in the first year, 2% the second, and 1% in the third year.
While permanent rate reductions can be beneficial depending on how long you stay in the home, temporary rate reductions aren’t likely to help you save money. However, they may offer other benefits, such as helping you manage monthly payments in the short term.
The benefits of buying down your mortgage interest rate
Often, discount points can be worth the upfront costs. Here are some benefits they offer:
- Save on interest payments: The primary benefit of buying down your mortgage interest rate is the potential savings over the life of the loan. By paying more upfront, you can significantly reduce the interest you’ll pay over the loan term. This applies only to permanent rate reductions.
- Reduced monthly payments: Temporary and permanent buydowns allow for lower monthly payments. This can allow buyers to free up funds for other expenses. It also makes sense for buyers who expect their income to increase within 2-3 years of getting a mortgage.
- Discount points are tax-deductible: Since discount points are a form of prepaid interest, they are tax-deductible in certain circumstances. Note that this typically only applies if you intend to use the home you’re buying as your primary residence.
The drawbacks of buying down your mortgage interest rate
On the other hand, purchasing discount points may not make sense for all buyers. Here are some of the drawbacks associated with them.
- High upfront costs: Discount points can add to the upfront (out-of-pocket) cost of purchasing a home. For some buyers, this may mean less money for other expenses like repairs or renovations.
- Not always cost-effective: The long-term discounts afforded by discount points may not be worth the cost for some buyers, especially those planning to refinance or sell their home soon.
Buying down your mortgage: what else to consider
Before deciding whether to buy down your mortgage interest rate, it’s essential to consider several factors. Here are some steps you can take to understand whether it’s worth it.
- Calculate the total cost of your mortgage over the entire loan term, factoring in the upfront cost of discount points.
- Determine how much money you’ll save each month by reducing your interest rate.
- Consider how long you plan to reside in the home or any potential refinancing plans you may have. If you refinance your home before you recoup the cost of the discount points, you may lose money. Make sure to look at current mortgage refinance rates to determine whether this is the case.
- Consider working with a financial advisor to help you determine whether discount points are worth the expense.
Remember that buying discount points may affect other areas of your budget, which may change your monthly payment in other ways. For instance, if your down payment is less than 20% of the purchase price, you’ll need to pay monthly premiums on private mortgage insurance. In this situation, increasing your down payment may be a better alternative to buying down your mortgage.
Disclaimer: Article content is intended for information only. It may not reflect the publisher nor employees’ views. Consult a mortgage professional before making financial decisions. Publishers or platforms may be compensated for access to third party websites.
