Discount points "buy down" a mortgage rate.
Home buyers sometimes get a lower mortgage rate by "buying down" the rate. A mortgage lender will offer loans at different rates, along with a corresponding cost in "points" to get a loan at the lower quoted rates.
Home buyers or refinancing homeowners may be willing to pay these points in order to get a specific rate so that they can save on interest or have a specific monthly payment. The extra cost for the lower rate is paid at the closing of the new loan.
Costs
The cost of buying down a mortgage rate is quoted in discount points. A single point is 1 percent of the loan amount. For example, if a lender quoted a certain rate with a cost of 2 discount points, the value of the points on a $400,000 mortgage would be 2 percent of $400,000, or $8,000. The use of points to price the rates results in a higher cost for larger loans and a lower cost for smaller loans
Effects
Each mortgage lender will list different rates and the cost in discount points to get each rate. one discount point will lower the rate one-eighth to one-quarter of a percentage point, depending on the type and term of the mortgage. A homeowner or buyer can determine the cost to buy down to a specific rate by taking the lender's discount points quote and multiplying the points as a percentage times the loan amount.
Significance
A borrower should compare the projected payment of a loan at the zero points rate to the payment if the rate is bought down. For example, if the zero point rate is 5.5 percent, a $400,000 loan would have a 30-year payment of $2,271. If the loan rate is bought down to 5.0 percent, the payment would be $2,147, a savings of $124 per month. In this example, assume the lender charges 3 points to buy down the rate to 5 percent. The upfront cost to buy down to the 5 percent rate would be $12,000
Potential
A home buyer should determine how long it will take to pay off the discount points with the monthly payment savings. In the example above, $12,000 divided by $124 shows it will take 97 months, or roughly eight years. If the borrower keeps the mortgage longer than eight years, it will make financial sense to buy down the rate. Over a full 30-year term, the 5 percent mortgage will have an interest savings of $44,000 in exchange for the $12,000 upfront payment.
Considerations
The cost of discount points and the amount of payment savings will vary according to the size of the mortgage loan. If the homeowner/buyer has sufficient equity in the home, the cost of the points can be rolled into the loan.
This will reduce the total savings but also avoid payment of the points up front. Buying down the interest rate can lower the monthly payment to help meet debt-to-income ratios to qualify for a specific mortgage.
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