How Much Does it Cost to Buy Down Interest Rate?

Last Updated on May 26, 2024
Written by CPA Alec Pow | Content Reviewed by Certified CFA CFA Alexander Popinker

Reducing mortgage interest rates through upfront discount points can provide substantial savings over the loan term via lower monthly payments. But how much does buying down rates actually cost on average?

Exact buy down costs depend on several key factors like the mortgage loan amount, lender fees, number of discount points purchased, type of buy down, and more. Gaining a full understanding of the costs, benefits, and strategic uses of rate buy downs allows borrowers to maximize savings potential. This guide examines permanent buy downs, temporary buy downs, cost calculations, breakeven analysis, pros and cons, and tips for saving.

How Much Does it Cost to Buy Down Interest Rate?

For a $300,000 30-year fixed-rate mortgage, purchasing one discount point to permanently lower the rate by 0.25% typically costs right around $3,000 upfront at closing. Buying two points to reduce rates by 0.50% runs approximately $6,000. Each additional point purchased further drops the rate by another 0.25% increment per point.

On a $200,000 home loan:

  • 1 discount point (0.25% rate reduction) costs approximately $2,000
  • 2 discount points (0.50% rate reduction) costs approximately $4,000

For a $500,000 mortgage:

  • 1 point (0.25% decrease) costs around $5,000
  • 2 points (0.50% decrease) costs around $10,000

On a $1 Million luxury home mortgage:

  • 1 point (0.25% reduction) runs about $10,000
  • 2 points (0.50% reduction) runs about $20,000

Rocket Mortgage explains the concept of a buydown, where a buyer can choose to lower their interest rate for a specific period by paying an upfront fee. They provide an example of a 3-2-1 buydown scenario where the buyer pays 2% interest in the first year, 3% in the second year, and 4% in the third year. The total cost of the buydown is estimated to be around $16,400, with varying monthly payments and savings over the years.

PacRes Mortgage offers a comprehensive guide on the cost of buying down an interest rate, stating that one point typically costs 1% of the total loan amount and can reduce the interest rate by 0.25% to 0.375%.

For instance, if you have a $400,000 loan and want to lower your interest rate by 1%, you may need to pay three to four discount points, totaling $12,000 to $16,000 at closing. The article emphasizes the importance of understanding the costs and benefits of buying down an interest rate and recommends consulting with a lender for specific details.

JVMLending goes into the details of buying down a mortgage interest rate, explaining that one discount point costs 1% of the total loan amount. For example, on a $500,000 mortgage, one point would cost $5,000 at closing.

The article also discusses the number of points that can be purchased, the impact of discount points on interest rates, and the breakeven point to consider when deciding whether to buy down an interest rate.

Reddit provides insights into the cost of buying down an interest rate, stating that it usually costs 1% of the loan amount to buy down 0.25% off the interest rate. For example, if you buy a house for $250,000 and put $50,000 down, you can pay an additional amount to the lender to lower the interest rate.

The cost of buying down an interest rate can vary based on individual financial profiles, loan types, and lender pricing, making it essential to consult directly with a loan officer for accurate information.

As you can see, buying down rates gets more expensive on higher loan amounts since points are calculated as a percentage of the mortgage total.

How Do Mortgage Discount Points Work?

  • Discount points are fees paid upfront when closing on a mortgage loan to permanently reduce the ongoing interest rate in set increments.
  • Each discount point typically decreases the interest rate by 0.25% (1/4th percentage point).
  • Points cost 1% of the total mortgage loan amount per each 0.25% incremental rate deduction.

Pros and Cons of Buying Down the Interest Rate

Potential Advantages of Rate Buy Downs:

  • Lower monthly mortgage payments
  • Pay significantly less interest over the 30-year loan
  • Allows qualifying for a larger mortgage amount

Possible Disadvantages to Consider:

  • Added closing costs to fund the upfront discount points
  • Locks up extra cash that could be invested elsewhere
  • Missed opportunity if selling or refinancing before breakeven

Now let’s look at a detailed permanent buy down example.

Case Study on a $300,000 30-Year Fixed Mortgage

  • Borrower receives 5.00% interest rate quote on $300,000 fixed mortgage
  • Purchasing 1 discount point for 0.25% reduction costs $3,000 upfront
  • Lowers the rate from 5.00% down to 4.75% for the full loan term

Potential Lifetime Savings:

  • $130 lower monthly mortgage payment
  • $46,800 less interest paid over 30 years
  • Break even period on point investment achieved in less than 3 years

In this example, the upfront cost to buy down the rate leads to substantial savings over the long run. Next let’s look at “temporary” buy downs.

How Do Temporary Buy Downs Work?

Buy Down Interest RateWith temporary buy downs, the rate reduction and savings only last for the first few years before rising back to the standard rate.

In a 2-1 temporary buydown structure:

  • Rate decreases 2% from standard rate in year 1
  • Rate decreases 1% from standard in year 2
  • In year 3, rate returns to original quoted rate

A 3-2-1 temporary buydown works as follows:

  • Rate reduces 3% below standard rate in year 1
  • Rate reduces 2% below standard in year 2
  • Rate reduces 1% below standard in year 3
  • In year 4, rate returns to original standard quote

Temporary buy downs provide short-term relief on mortgage payments. Now let’s examine cost calculations.

Calculate Costs for Buying Down Mortgage Rates

The costs can be easily estimated based on just a few key mortgage details:

  1. Mortgage Amount (ex. $300,000)
  2. Standard Interest Rate Quote (ex. 4.5%)
  3. Number of Discount Points to Purchase (ex. 2 points)
  4. Multiply Mortgage Amount x Number of Points x 0.01 = Buy Down Cost

For example, on a $300,000 mortgage:

2 points would cost:

$300,000 mortgage x 2 points x 0.01 = $6,000

This allows quickly estimating buy down costs. Now let’s analyze a case study.

Case Study on a $500,000 30-Year Mortgage

  • Borrower offered standard rate of 4.75% on $500,000 fixed mortgage
  • Wants to buy down rate 0.50% (2 discount points)
  • Plugs details into calculator to determine costs
  • $500,000 mortgage amount
  • 2 discount points purchased
  • $500,000 x 2 x 0.01 = $10,000 total cost
  • Buys down rate from 4.75% to 4.25% permanently

You might also like our articles about the cost of timeshare lawyers, title searches, or allodial titles.

Using the quick calculation formula allows determining costs based on real mortgage specifics to evaluate the investment.

Using Discount Points

  • Shop lenders for the lowest base rate quotes before buying points
  • Buy down rates further when offered low base rates for enhanced leverage
  • Consider temporary buy downs when needing short-term relief
  • Plan for how long you’ll keep the home before points “break even”
  • Use online calculators to estimate your breakeven timeline and interest savings
  • Consult mortgage and financial advisors to weigh pros and cons for your situation

With the right mortgage strategy, rate buy downs can provide substantial savings over the loan term.

Should You Pay Discount Points?

When points may make sense:

  • Plan to keep the home beyond the breakeven period
  • Offered an exceptionally low base rate – points buy down further
  • Large mortgage where small rate changes have bigger impact

When paying points may not provide value:

  • Unsure about long-term plans for the home
  • Low mortgage amount where savings are minimal
  • Planning to make extra payments to pay off loan early

Assess your specific situation carefully when evaluating using points.

Refinancing Considerations

  • If refinancing, discount points from previous mortgage don’t carry over
  • Must decide if buying points again on new loan is worthwhile
  • Shop lenders for best overall rate with minimal points needed
  • Calculate new breakeven timeline based on refinanced amount

Evaluate whether points still make sense or not when refinancing.

Alternatives to Buying Down Rates With Points

  • Lower rate with points vs. higher rate with lender credit
  • Lender credits offset closing costs but don’t lower rate
  • Compare lifetime interest savings vs. upfront closing costs
  • Consider differences in monthly payment as well

Looking at total cost and payment is key when comparing options.

Saving on Mortgage Interest

  • Shop multiple lenders for the lowest base rate quotes
  • Make extra principal payments to reduce interest costs
  • Deduct mortgage interest on taxes if itemizing
  • Monitor rates for refinancing opportunities to lower rate
  • Avoid cash-out refinancing which increases rates and costs

Combine strategies to maximize lowering rates and interest over time.

Final Words

Reducing mortgage interest rates by paying discount points upfront at closing can lead to considerable savings over the loan term through lower monthly payments and lifetime interest reductions.

Carefully evaluating costs against your unique home financing goals and timeline allows maximizing the value derived from strategically buying down rates. With the right approach, points can offer borrowers a worthwhile investment.

Frequently Asked Questions

Is it worth it to buy down interest rates?

For those planning to keep the home long term beyond the breakeven period, usually 5-7 years, buying down the rate with points often pays off in the end through lower monthly payments and total interest savings over the loan timeline. But carefully calculate the breakeven period to confirm the payoff based on your loan specifics.

Can you permanently buy down interest rates?

Yes, permanent rate buy downs purchased upfront at closing lower the ongoing mortgage interest rate by a fixed amount, such as 0.25% or 0.50%, over the full length of a 30-year or 15-year fixed-rate mortgage. This provides lasting interest savings over time.

How much is a 2:1 buydown?

A 2:1 temporary buydown on a $300,000 30-year fixed-rate mortgage will generally cost between $4,000 to $8,000 depending on lender fees. It buys the rate down by 2% in year 1 and 1% in year 2 before returning to the lender’s standard rate in year 3 when the buydown expires.

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