When shopping for a mortgage, you'll often hear about "buying down your rate" or "paying points." But what does this really mean, and more importantly, is it worth your money? Let's break it down.
What Are Mortgage Points?
Mortgage points, also called discount points, are fees you pay at closing to reduce your interest rate. One point equals 1% of your loan amount.
The Basic Trade-off
Pay more upfront → Lower monthly payment → Save money over time
Example:
- Loan amount: $400,000
- 1 point = $4,000
- Typical rate reduction: 0.25% per point
Types of Points
Discount Points
These directly reduce your interest rate. You're essentially prepaying interest to get a lower rate for the life of your loan.
Origination Points
These are lender fees for processing your loan. They don't reduce your rate—they're just a cost of getting the loan.
Important: When comparing lenders, make sure you're comparing apples to apples. Some advertise low rates but charge more in origination points.
The Math Behind Buydowns
Calculating Your Break-Even Point
The key question: How long until your monthly savings exceed what you paid?
Formula: Break-even = Cost of points ÷ Monthly savings
Real Example
Let's compare two scenarios on a $400,000 loan:
Option A: No points
- Rate: 7.0%
- Monthly payment: $2,661
- Points cost: $0
Option B: 2 points
- Rate: 6.5%
- Monthly payment: $2,528
- Points cost: $8,000
Monthly savings: $2,661 - $2,528 = $133
Break-even: $8,000 ÷ $133 = 60 months (5 years)
If you keep the loan longer than 5 years, Option B saves money. If you sell or refinance sooner, Option A is better.
Temporary Rate Buydowns
Beyond permanent buydowns, there are temporary options that reduce your rate for the first few years:
2-1 Buydown
- Year 1: Rate is 2% below the note rate
- Year 2: Rate is 1% below the note rate
- Year 3+: Full note rate
Example with 7% note rate:
- Year 1: 5% ($2,147/month)
- Year 2: 6% ($2,398/month)
- Year 3+: 7% ($2,661/month)
3-2-1 Buydown
- Year 1: Rate is 3% below
- Year 2: Rate is 2% below
- Year 3: Rate is 1% below
- Year 4+: Full note rate
Who Pays for Temporary Buydowns?
Often sellers! In a buyer's market, sellers may offer to pay for a buydown as a concession. This can be more valuable than a price reduction.
When Buying Points Makes Sense
Good Scenarios for Points
- You plan to stay long-term: If you'll keep the loan past break-even, you'll save money
- You have extra cash: If you've already maxed your down payment
- Seller concessions available: If the seller will pay for points as part of negotiations
- Marginal qualification: Lower payment might help you qualify
When to Skip Points
- Short-term ownership: Planning to move in a few years
- Limited cash: Down payment and reserves are more important
- Rates are dropping: You might refinance soon anyway
- Better use of funds: Emergency fund or home improvements may be priorities
Negotiating Points with Sellers
In today's market, asking sellers to contribute toward your rate buydown can be smart:
Benefits for Buyers
- Lower monthly payment
- Easier qualification
- Immediate cash flow benefit
Benefits for Sellers
- May attract more buyers
- Can justify higher asking price
- Shows as a concession, not a price cut
How to Structure It
Instead of asking for a $10,000 price reduction, consider:
- Request $10,000 toward a 2-1 buydown
- The monthly savings are immediate and tangible
- Can be more persuasive than a small price change
Points vs. Other Uses of Cash
Before paying for points, consider if your money could work harder elsewhere:
Compare These Options
- Larger down payment: Reduces loan amount and potentially eliminates PMI
- Emergency fund: Financial security is valuable
- Home improvements: May increase value or enjoyment
- Investment: Could your money earn more invested?
The PMI Factor
If you're putting down less than 20%, eliminating PMI might be a better use of cash than buying points.
Example:
- PMI cost: $200/month
- Extra 5% down to eliminate PMI: $20,000
- Points to save $200/month: Would cost much more
Tax Considerations
Mortgage points may be tax-deductible, but the rules are specific:
On a Purchase
- Points are typically deductible in the year paid
- Must be customary for the area
- Must be calculated as percentage of loan
On a Refinance
- Points must be amortized over the life of the loan
- Exception: Points used for home improvement may be deductible immediately
Note: Always consult a tax professional for your specific situation.
How to Decide
Step 1: Calculate Your Break-Even
Use the formula above or ask your lender for scenarios.
Step 2: Estimate Your Timeline
How long do you realistically plan to:
- Live in this home?
- Keep this mortgage (considering potential refinances)?
Step 3: Compare Alternatives
What else could you do with the money? Is that better or worse?
Step 4: Consider Seller Contributions
Can you negotiate for the seller to pay some or all of the buydown cost?
Questions to Ask Your Lender
- What rate can I get with 0, 1, and 2 points?
- What's my break-even for each scenario?
- Are there any temporary buydown options?
- How do points affect my closing costs?
- What's the origination fee separate from discount points?
Navigating mortgage options can be complex. Savant Homes' mortgage team can help you analyze whether buying points makes sense for your situation. Contact us for a personalized consultation.