Strategy for Buying Down Interest Points to Reduce Your Interest Rate

When you're in the market for a home, one crucial factor to consider is the current interest rate. It can have a significant impact on your monthly mortgage payments and the overall cost of your loan. However, there's a lesser-known strategy that can help you secure a lower interest rate and potentially save thousands of dollars over the life of your mortgage: buying down interest points. In this blog post, we'll explore what buying down interest points means, how it works, and whether it's the right choice for you.

Understanding Interest Points

Interest points, also known as discount points, are a form of prepaid interest that can be paid upfront to reduce the interest rate on your mortgage. Each interest point typically costs 1% of your loan amount and can lower your interest rate by a fraction of a percentage point. The more points you purchase, the lower your interest rate will be, and the less you'll pay in interest over the life of your loan.

How Buying Down Interest Points Works

Let's take a closer look at how buying down interest points can work in practice:

1. Calculate Your Savings: Before deciding to buy down points, it's essential to calculate how much you can save. You can do this by comparing the interest rates your lender offers at different point levels. The potential savings depend on the current market conditions and your mortgage term length.

2. Determine Your Break-Even Point: To make an informed decision, calculate your break-even point. This is the point at which the money you save on your monthly mortgage payments equals the cost of the interest points. Once you reach the break-even point, the savings continue to accumulate.

3. Weigh Short-term vs. Long-term Benefits: It's crucial to consider your future plans and how long you intend to stay in your home. If you plan to live in your home for a long time, buying down interest points can be a smart investment, as you'll enjoy more significant long-term savings.

Real-Life Example: If a seller of a 500K home offered a $10,000 credit to the buyer at closing, the buyer can buy down points and reduce their interest rate.  This equates to roughly $40,000 in savings over the life of the loan for a 30-year mortgage. 

Pros and Cons of Buying Down Interest Points

Like any financial strategy, buying down interest points has its advantages and disadvantages:

**Pros:**

1. **Lower Monthly Payments:** Buying down points can significantly reduce your monthly mortgage payments, making homeownership more affordable.

2. **Long-term Savings:** Over the life of your loan, you can save thousands of dollars in interest, making it a wise investment for those planning to stay in their homes for an extended period.

3. **Tax Benefits:** In some cases, the points you purchase may be tax-deductible, offering potential tax savings.

**Cons:**

1. **Upfront Cost:** Purchasing interest points requires a lump-sum payment at closing, which can be a financial strain for some buyers. Buyers can ask for a "seller contribution" to their closing costs instead of a price reduction. 

2. **Market Fluctuations:** Interest rates can be unpredictable. If you buy down points and rates drop, you might not see as significant savings as you had hoped (not really a risk in our current 2023 market).

3. **Break-Even Period:** It may take several years to reach your break-even point, so this strategy may not be the best choice for those planning to sell their homes in just a couple of years or with the possibility of relocation.

Conclusion

Buying down interest points can be a powerful tool for reducing your interest rate and saving money on your mortgage. It's essential to consider your financial situation, future plans, and the current interest rate market when deciding whether to purchase points. While it can be a savvy financial move for some, it may not be the right choice for everyone. Consulting with a mortgage professional can help you assess your options and make an informed decision tailored to your unique circumstances. Whether you choose to buy down interest points or not, understanding this strategy empowers you to make the best decision for your financial well-being when it comes to your mortgage. Contact me for referrals or any other real estate-related questions or needs.