Should You Buy Down Your Mortgage Rate?
Buydowns are most beneficial when a seller or builder offers to pay the discount points on behalf of the buyer without significantly increasing the purchase price of the home. However, if the buyer intends to pay the points themselves, there are certain circ*mstances in which mortgage buydowns are more suitable.
When You Should Use A Buydown
To begin, you must have enough savings to afford to pay for a down payment and closing costs and still have a significant amount of cash left over. If that’s the case, having lower payments in the first few years may be beneficial if you expect your income to be considerably higher in the future.
For example, a buydown may make sense for a graduate student who believes their income will double after receiving their degree. Buying down a mortgage would also make sense if a stay-at-home parent were planning to return to work a couple of years after obtaining their loan.
But keep in mind that buydowns are all about paying more money upfront so you can save money in the long run. Therefore, buydowns only really make sense if the buyer in question intends to own the home for an extended period of time.
The Breakeven Point
To determine if a buydown is worthwhile, you must calculate the breakeven point. The breakeven point is the amount of time it’ll take to recoup the cost of the discount points required to lower your interest rate. To do the calculation, you divide the cost of the discount points by the monthly savings.
Breakeven Point = (The Cost Of Points) ∕ (Monthly Savings)
Let’s take a look at a simplified example of how this would work. If you’re looking to obtain a 30-year, $300,000 mortgage with an interest rate of 7%, and your lender charges you four points to reduce your interest rate by 1%, you would first calculate the cost of the points.
Since each point costs 1% of the purchase price, the total cost would be $12,000. By paying 6% in interest instead of the standard 7%, your mortgage payments would drop from $1,995.91 to $1,798.65. Therefore, your monthly savings would be $197.26.
$12,000 divided by $197.26 comes to 60.83, so 61 months is the breakeven point. That means it would take you about 5 years and a month to recoup the money you’d have to spend on discount points.
If you, as the buyer, think there’s a chance you’ll sell the home or refinance before the 61-month mark, a buydown wouldn’t make sense for you. Instead, you’d want to think about making extra payments, as you can also save money on interest by paying off your mortgage early.
