Should You Buy Down Your Interest Rate? Understanding the Costs and Benefits

This isn’t a department store membership card; it’s the strategy behind mortgage rate buydowns—a method for homebuyers to get a better rate immediately.

But should you buy down your interest rate?

When looking at interest rates in 2024, you might find yourself asking:

How much does it cost to buy at a lower rate?
What are mortgage points?
Is it worth it?

In this article, we’ll address these questions to help you understand how buying down your interest rate can save you money on your home loan.

What is a rate buydown?

A rate buydown allows borrowers to pay less interest over the life of their loan. This can be done in two ways.

Permanent buydown

You purchase discount points at closing, which reduces the interest rate for the entire loan term.

This means you’ll pay less interest over the life of the loan, leading to lower monthly mortgage payments from the outset and potentially significant savings over the long term.

Temporary buydown

You make an initial payment to temporarily lower the interest rate, typically for the first one to three years of the loan term.

During this time, your monthly payments are reduced, making the early years of homeownership more manageable.

After the temporary period ends, the interest rate returns to the original rate outlined in the loan agreement, resulting in higher monthly payments.

What are mortgage points?

Mortgage points refer to fees that borrowers can pay to their lender at closing to lower the interest rate on their mortgage.

Typically, there are two kinds of mortgage points available.

Origination points

These cover the lender’s administrative costs for processing your loan.

Discount points

Points are payments made upfront to lower your mortgage interest rate for the life of the loan. This article focuses on discount points directly related to mortgage rate buydowns.

By purchasing discount points, you’re essentially pre-paying interest to secure lower monthly mortgage payments throughout the loan term.

How much does it cost to buy down your rate?

When considering a mortgage rate buydown, it’s important to know the cost:

One discount point typically costs 1% of your total loan amount and can lower the interest rate by 0.25% to 0.375%, depending on your lender, loan type, and market conditions.

For instance, to lower your interest rate by 1%, you may need to purchase three to four discount points. This means paying 3% to 4% of your total loan upfront.

For a $400,000 loan, reducing your rate from 7% to 6% might cost you $12,000 to $16,000 at closing.

Who pays for the buydown?

The buyer, seller, or builder can cover the cost of a rate buydown.

Often, sellers or builders will pay for the buydown as part of negotiations or to make the deal more attractive.

How long does a buydown last?

A buydown can impact your interest rate and monthly payments either permanently or temporarily:

Permanent buydown: The lower rate lasts for the life of the loan.
Temporary buydown: The lower rate lasts for a specified period, after which the interest rate returns to the original level.

Common buydowns

1-0 buydown: The lower interest rate lasts one year and then reverts to the original rate.
2-1 buydown: The first-year rate is 2% lower than the contract rate, the second-year rate is 1% lower, and from the third year onward, the original rate applies.

Less common buydowns

3-2-1 buydown: The first-year rate is 3% lower, the second-year rate is 2% lower, and the third-year rate is 1% lower. From the fourth year onward, the contract rate applies.

Benefits and considerations of a temporary rate buydown

Temporary buydowns offer several benefits:

Save on interest: A lower rate in the initial years can save you thousands of dollars.
Lower monthly payments: A reduced rate can make homeownership more affordable in the early years.
Better deals: If the seller doesn’t lower the house price, they might offer a rate buydown as a concession, saving you money on interest.

However, temporary buydowns are just that—temporary.

The upfront fees can be substantial, and the higher interest rate after the buydown period may strain your budget.

When is a temporary rate buydown an option?

Not all loans qualify for a temporary mortgage rate buydown. Primary or secondary residences are typically eligible, but investment properties are not.

Regulations vary by loan type. Conventional, FHA, VA, and USDA loans all limit the number of points sellers or builders can contribute.

Calculating long-term savings

To determine if a buydown is worth it, consider its duration and whether your loan is eligible.

A seller- or builder-paid buydown is usually worth it, as it allows you to enjoy a lower rate without additional costs.

But if you’re paying for the buydown, calculate the break-even point.

Cost of the points / Monthly savings = Break-even point

For example, if a $400,000 loan costs $16,000 to buy down by 1%, the monthly savings from lowering the rate from 7% to 6% would be $400.

It would take 40 months to recoup your $16,000 investment, making it worthwhile if you plan to stay in the home longer than that.

Alternatives to buying down a mortgage rate

If the math doesn’t work out in your favor, consider other options to reduce your interest rates or monthly payments:

Negotiate the purchase price: Paying less for your home means you’ll need to borrow less money, which results in lower monthly payments.
Adjustable-rate mortgage (ARM): This loan type offers a lower initial rate for a set period before adjusting to market rates.
Refinancing: If rates have improved since you took out your loan, refinancing might save you money, or you could opt for a shorter-term loan to reduce interest.