Buying Down The Rate

Buying down the rate is when you pay a fee to the mortgage lender for a lower interest rate. The most widely recognized payment is a “1 point buydown,” which typically reduces the mortgage rate by 0.125% – 0.375%.

Is buying down the rate worth it? Let’s find out.

How Is It Figured Out?

The calculation of the fee is simple; a 1-point buydown 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 buydown does not always result in the same reduction in interest rate).

Below I discuss the basic structure of buying down the rate, what the labels are, and how to best use this option on your next refinance or purchase transaction.

The Actual Buydown

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“. Loan Officers usually lump in Loan Origination fees as well (when discussing buying down the rate).

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 buydown 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 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, 6.00% with zero points
• 30-year fixed-rate, 5.625% with one point

In this example, when you pay one point, 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 moved more than 0.125% for the second point.

It’s important to know that if you are buying down the rate, then that fee should be listed on your locked Loan Estimate.

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.

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 Required?

Buying down the rate is not required even if your Loan Officer says it is (find a new mortgage company if this is happening to you).

The fact is there are some mortgage lenders who 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. They are overcharging their clients.

So if are working with a company like this and you wanted to buy down the rate with two points, that could mean $9,000 in points (based on a $300,000 loan amount). One point for the Loan Origination fee and two Discount points to buy down the rate (see below for the difference between Loan Origination fees and Discount points). That’s a significant amount of money.

Many reputable lenders do not require you to pay a Loan Origination fee on every loan option, and they usually offer an option without a Loan Origination fee. I suggest you avoid lenders that don’t offer an interest rate option without Loan Origination fees.

The Difference Between A Loan Discount and An 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).

A Buydown Scenario

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 6.00%, and your only costs are the regular closing costs fees, and option two is with a 1% buydown (aka 1 point) plus closing costs with a rate of 5.625%.

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, then option two usually makes sense; however, if you refinance or move too soon, then that “lower rate” just ends up costing you more money.

Every situation is different, so I suggest you question the benefits of buying down the rate (or not buying down the rate). With some loan scenarios, it does make sense, so don’t be completely opposed to the idea of paying an upfront fee to get a lower mortgage rate.

If you buydown the rate, make sure you’re clear on how long it will take for you to see the actual savings of the lower rate.

Here Is How To Calculate The Benefit Of Buydown

If your loan amount is $300,000, and you have the choice between a 30-year fixed rate at 5.50% and a 30-year fixed rate at 5.00% with a one-point buydown, here is how you do the math to see if there is a benefit to buying down the rate.

• Establish how long you know you’ll keep the loan. For this example, we’ll set that at 5 years.
• Write down the difference in cost between the two loans ($3,000).
• Calculate the difference in payment between the two loans ($1,703.37 – $1,610.46).

The five-year monthly payment savings is $7,194.60. So if you spend $3,000 up front, you’ll save $4,194.60 over the first five years so in this example, I would suggest to a client to strongly consider the buydown rate option.

When It Makes Sense To Buydown The Rate

Deciding if buying down the rate makes sense 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), then you probably want to make sure you make back the cost to buy down the rate in four to five 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 an acceptable time frame. And be conservative in your timeframe; otherwise, you’ll be at greater risk to pay more for the loan than you need to. Life changes, so you don’t want to risk paying fees and not seeing the benefit of paying that fee.

Can You Buydown The Rate On A 15-Year Fixed Mortgage?

Absolutely. You can buy down the rate 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 to come out of pocket on a purchase loan is by 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.