Buying down the rate in California is when you pay a fee to the mortgage lender for a lower interest rate. The most widely recognized payment is “1 point buy down” which typically reduces the mortgage rate by 0.25% +/- (when compared to a mortgage rate in which you are not buying down the rate).
So How Is It Figured Out?
The calculation of the fee is simple; a 1 point buy down on a $200,000.00 loan amount equals $2,000.00.There’s not a set equation when it comes to buying down the rate (meaning a one point buy down does not always result in the same reduction in interest rate).
Below I discuss the basic structure of what it means to buy down the rate, what points are and how to best use this option on your next refinance or purchase transaction.
The Actual Buy Down
Years ago someone came up with the idea that a borrower could pay a fee to lower the interest rate and thus the term “buying down the rate” was created. Buying down the rate refers to points, specifically “Discount Points“. What you are doing is prepaying some of the interest the mortgage lender would like to collect on your loan.
“One point” is the most common way of understanding what a buy down is, however, you can have less than one point or more than one point. A borrower can pay as little as one-eighth of a point up to two or three points. Generally, it goes is in eight increments but not all the time.
As mentioned above; the reduction of the rate is not always the same. For example; let’s say your Loan Officer quotes you two 30-year fixed rate options:
- 30-year fixed-rate, 4.00% with zero points
- 30-year fixed-rate, 3.625% with one point
In this example, the interest rate moves lower by 0.375%. It would be logical to think that to pay another point the rate would drop by another 0.375% but that is not the case. In fact; I would be surprised if the rate was to move more than a 0.125%.
Doing The Buydown Calculation
To figure out your cost associated with the buying down of the rate simply times the loan amount by 1% (or whatever the percent of the buy down is) and that will give you the amount you are paying to obtain a lower mortgage rate.
|0.25||A quarter of one point||0.0025||0.0025 x $200,000 =||$500|
|0.50||Half of one point||0.005||0.005 x $200,000 =||$1,000|
|1.00||One point||0.01||0.01 x $200,000 =||$2,000|
|2.00||Two points||0.02||0.02 x $200,000 =||$4,000|
When you buy down the rate it’s usually a cost in addition to regular closing fees.
So for example; if you were getting a new mortgage with a 1% buy down plus closing costs and your loan amount was $300,000.00 then you would pay $3,000.00 plus the regular closing costs associated with the loan.
For a $300,000 loan amount, your typical closing costs for lender fees (underwriting), appraisal, title, escrow, and recording are going to be $2,950.00.
On a refinance you usually can roll these costs into the loan however on a purchase they must be paid upfront by either the buyer or with a seller credit towards closing costs.
Is Buying Down The Rate In California Required
Buying down the rate in California is not required.
I know some mortgage lenders will say all their loan options come with at least one point and then after that you can buy down the rate with additional discount points.
So if you wanted to buy down with the rate with this company that could mean $6,000 in additional fees (based on a $300,000 loan amount). One point for the Loan Origination fee and one point for the Discount Point. That’s a significant amount of money and it almost never makes sense to pay that much.
Many reputable more lenders do not require you to pay a Loan Origination point as it’s usually built into the interest rate. I suggest you avoid lenders that don’t offer interest rates without Loan Origination fees.
The Difference Between A Loan Discount and Origination Fee
The difference between a Loan Discount fee and a Loan Origination fee is this:
- Discount fees are used to buy down the interest rate.
- Origination fees are compensation to the Loan Officer/mortgage lender for services rendered.
That being said many mortgage lenders mix the two together. Loan Origination fees are calculated the same way Discount points are (see table above).
Two Buydown Scenarios
Getting the best mortgage rate does not always mean getting the lowest mortgage rate.
What do I mean by that?
Let’s say you have two options when getting a new mortgage; option one is at 4.00% and your only costs are the regular closing costs fees and option two is with a 1% buy down plus closing costs with a rate of 3.75%.
It’s clear that option two has a lower interest rate when compared to option one. What’s not clear is which is the best mortgage rate.
Now if you stick with the loan for a long time option two usually makes sense however if you refinance or move too soon than that “lower rate” just costs you more money.
Every situation is different but generally, it’s questionable as to whether there is a benefit to buying down the rate based on current mortgage spreads. With some loan scenarios it does make sense, so don’t be completely opposed to the idea. If you do buy down the rate, make sure you’re clear on how long it will take for you to see the actual savings of the lower rate.
When It Makes Sense
In the two examples above the best mortgage rate depends on how long you will keep the loan. If you are keeping the loan for less than five years (meaning you’ll refinance or move) than you probably want to make sure you make back the cost to buy down the rate in two to three years.
If your plan is to keep the loan for longer than that then make sure you recoup the cost to buy down the rate in five years or less. Anything longer than five years is risky. Life changes so you don’t want to risk paying fees and not seeing the benefit of paying that fee.
Can Buy Down The Rate On A 15 Year Fixed Mortgage?
Absolutely. You can buy down the rate in California on any fixed or adjustable-rate term.
Fixed-Rate vs Adjustable Rate Buydown
This isn’t always the case but usually, fixed-rate loan terms provide a “bigger bang for the buck” than Adjustable Rate buydowns. It’s just the way the market is structured and buy-downs tend to favor fixed-rate terms.
Purchase and Refinance Loans
Buydown options are available on both purchase and refinance loan options. It’s less common to see someone paying a one point buy down on a purchase loan because with a purchase loan you have to come out of pocket for all your fees.
So in addition to all the general lender, title and escrow fees (fyi – title and escrow fees are higher on a purchase) you’ll also have to come up with thousands more for the interest rate buydown.
One way to avoid having come out of pocket on a purchase loan is requesting the seller to cover some of your closing costs by providing a seller credit back to you.
With our refinancing loan programs, you can simply roll the buydown into the total loan amount.