Mortgage 101 – The truth about buying down your interest rate

Buying down your interest rate is also known as “discount points.” In this topic, I will discuss what a discount point is, an example of what it does and how to do the math to see if it makes sense for you.

Discount points lower your interest rate and payment for an upfront cost. The cost of one discount point is 1% of the loan amount and this will generally lower your interest rate about .25%. You can buy down the rate as much as two discount points on most mortgages.

Example:
Option 1 – $200,000 @ 4.25% for 30 years = $984
Option 2 – $202,000 @ 4.00% for 30 years = $964

Option 1 is with no discount points while option 2 is buying 1 discount point for a cost of $2,000. Option 2 saves you $20 more per month. The cost of the $2,000 upfront cost divided by the savings of $20 will take 100 payments or 8.3 years to recoup. However, if this mortgage is kept for the duration, the $2,000 upfront investment will save you $7,020 over the life of the loan.

After my research, the only time buying down an interest rate makes sense is if you plan on keeping the loan past the time it takes to recoup the additional cost. If you are considering buying down the interest rate, take the monthly savings divided by the cost to see how many months it will take you to surpass the break even point.

Discount points can be tax deductible as well as interest. Consult your tax advisor to maximize this deduction.

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-Charles W.

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