An interest rate buy-down is also known as mortgage points or discount points. These fees are a kind of prepaid interest due at the time of closing. You pay the points in order to reduce your interest rate on your home loan.
One point costs 1% of your mortgage amount. In other words, it is equivalent to $1,000 for every $100,000 of your mortgage. In general, each point will subsequently lower your mortgage interest rate by 0.25%.
For example, let’s suppose you have a $200,000 home loan over a loan term of 30 years. The interest rate is 4.1% without points. If you purchase 1 point for $2,000, your new interest rate is 3.85%. Your monthly payment without points would have been $957. Your new monthly payment with points would be $938. That is a monthly savings of $19.
There is a “breakeven period” at which the upfront cost of the discount points is equal to your savings from your monthly payments. In our example, the breakeven point is at 105 months or approximately 8.8 years.
Note that this is an upfront cost due at closing. The first thing to consider is if you can afford the mortgage points in addition to your other closing costs and down payment.
Mortgage discount points are beneficial if you plan to stay in your home longer than the breakeven period. If you intend to move or refinance your loan sooner than the breakeven period, it may be better to use those funds towards a larger down payment.
Your interest rate buy-down options are formally listed in your mortgage rate quote on a form called the Loan Estimate.
Your Loan Estimate should clearly state what kind of loan you’re getting, your interest rate, and your closing as well as future monthly costs. Your interest rate buy-down options should be listed under the heading “Costs at Closing.” This section shows the charges that you can shop for to reduce your costs.
Borrowers may consider getting a quote that includes two options: one mortgage estimate with discount points and one home loan estimate without discount points.
Your Closing Disclosure is a form that you receive three days before your closing date. This form finalizes the loan agreement and states the total amount due at closing. This number should include your interest rate buy-down fee, as reflected by the corresponding lower interest rate.