What is A Rate Buy Down When Buying a Home?

With home prices slowing their appreciation but interest rates escalating, a great idea that can help both home buyers and sellers is a Rate Buy Down.  Of course, you always need to take a look at cost vs. effect and how important your monthly payment is to you.  For a lot of people, monthly payment is what they care about the most.

So, what is a rate buy down?  Well, it really is exactly how it sounds. You pay to get your percentage rate down. You pay a one time fee  in advance to get a lower percentage rate for your mortgage interest.  You do this by purchasing discount points which usually cost 1% of the loan each. Each point in turn generally equals .125% to .375% discount on your rate. The fee for discount points is paid up front at closing, therefore your closing costs will be higher. 

Here is where it gets exciting, especially in a market like todays.  If you are a buyer and you’re interested in a home but the monthly payments are too high, talk with your lender about how discount points could affect your rate and monthly payment. If a seller refuses to drop their asking price,  maybe they would be willing to pay a certain amount to closing costs which would include discount points.  Not to mention when a seller does state that they are offering a certain amount towards closing costs, and your closing costs come to less than the seller is offering, use up the rest of what they are offering for discount points.

Now sellers, discount points can benefit you as well.  They can be a great tool in negotiations.  Say a buyer is interested in your house but they offer under asking price.  An option for you is to have your agent negotiate the higher price along with paying for discount points to help the buyer get their monthly payment down.  The buyer may be willing to pay the higher price if their payment is lowered and the seller may actually pay less for the discount points than the amount they would have had to drop their price. This is really a win-win situation.  Sellers who offer to pay discount points in any market make their home more attractive to potential buyers and possibly help their home to sell faster.

I want to stress that buyers should always make sure they understand what they are getting into before they tell their lender to sign them up.  Discount points can save them money but this is not guaranteed and certainly don’t return savings in every situation.  For example, homeowners who do not stay in their home for very long will not realize any savings from discount points.  You must stay in the home long enough to at least break even or it’s not worth the cost. To figure out how long you will have to stay in your home for it to be cost effective you need to divide the total cost of the points by how much you save on your monthly mortgage payment. 

( Total Cost of Points ÷ Monthly payment savings = Months needed to break even)

There are other factors involved when considering discount points. Obviously, if the seller is not paying for the points, then the buyer must have the money to pay upfront at closing.  Where the buyer is getting that money should factor into the cost effectiveness.  It is one thing if the money is a gift and a whole other thing if it is coming from their 401k.  They need to factor in the payments and time to pay back their 401k not to mention the loss of the possible returns on that investment. This is only one scenario of where the money could come from, a buyer needs to make sure to factor in the cost of any option they consider.  When a seller is paying for discount points, the buyer must remember that sellers are limited as to how much they are legally allowed to contribute to closing costs and discount points are included in this total.  There are different limits for different loan types along with a few other considerations.  

When it comes down to it, there is a real possibility that discount points could offer home buyers and sellers benefits.  Don’t forget to look into them when you're in the market, not to mention if you're waiting to join the market, find out if they can get you where you want to live faster!

If you’d like to discuss discount points and other options that may help you to get into your dream home sooner, comment below.