Paying Points to Buy Down Your Interest Rate

Historically, and on average across the nation, most consumers have paid just under one discount point to obtain the rate for their mortgage. One point is 1% of the loan amount. In the Washington metropolitan area—where the average length of time a consumer owns their home is lower than the national average—buyers have typically paid zero discount points at closing for their mortgage interest rate. During the past decade (with interest rates truly at historic lows), there was little incentive for borrowers to increase closing costs by “buying down” their rates. As home prices rose, down payment and closing costs also increased, and most consumers saw little benefit of increasing their cash requirements further by paying points to secure an even lower rate.

With a shift in the housing market and with rates on the rise, there is renewed interest in the potential benefit of buying down the interest rate. First, there is the psychological impact of securing a lower rate. If a buyer is flush with cash, they may choose to apply some of that toward obtaining what they perceive to be a more palatable rate, but available cash is still an issue for many buyers. Here is where the market shift comes into play. Sellers have had no incentive to offer or agree to concessions over the past number of years. With multiple offers on the table, sellers did not need to sweeten the pot for buyers. As the market changes, however, sellers may see more offers where the buyer is asking for closing cost assistance which can be used to buy down the purchaser’s interest rate. Depending on how anxious the seller gets, they may be inclined to agree to such a request.

The decision to pay points is really a cost benefit decision. The buyer should consider the additional upfront cost of buying down the interest rate against the benefit of the lower monthly payment associated with the lower rate. Those costs and benefits shift as rates move up and down, but the analysis process is always the same. Today for instance, the rate for a 30-year fixed rate loan of $750,000 with zero points would be 6.625%. The monthly principal & interest payment would be $4,802. If the borrower pays one discount point and buys the rate down to 6.250%, they will lower the payment to $4,618 per month. The cost of that buydown would be an additional $7,500 at closing and the benefit would be a monthly savings of $184. The borrower would break even in 41 months, not taking into account the tax deductibility of paying points when purchasing a primary residence. Paying two discount points would drop the rate to 5.875% and lower the payment a total of $365 per month with the same break-even period of 41 months. The real benefit comes every month after the break-even point. There are some federally-imposed limits on how many points a buyer can pay and still obtain a mortgage the federal government classifies as a qualified mortgage. Generally, a buyer can pay no more than 3 discount points, and often, the calculations end up limiting the points to just under 3.

For a seller, there may be benefit in offering to assist a purchaser in buying down their interest rate. It may make a seller’s property more attractive to prospective buyers. An alternative to lowering the asking price for a property may be to offer a buyer closing cost assistance which can be used to lower the rate. Closing cost assistance from a seller—if used to lower the interest rate—can have a larger impact on the buyer’s monthly payment than a reduction in the sales price of the same amount. Take for instance the example of a $750K mortgage and assume that represents 80% of the seller’s asking price of $937,500. We have already seen that paying 2 discount points to buy the rate down will lower the payment $365 per month. The cost of that is $15,000 at closing. A reduction in the sales price of $15K with a loan equal to 80% at the zero-point interest rate of 6.625% would result in a monthly payment of $4,725. That is only $77 per month lower than the payment on the higher sales price. .

If you are in the market to purchase a home, discuss the costs and benefits of paying points with a qualified mortgage professional. It can be an important tool in today’s market.

Brian Bonnet | Senior Loan Officer
Atlantic Coast Mortgage, LLC | NMLS ID 643114
e: bbonnet@acmllc.com | t: 703-766-6702 | NMLS ID 224811

A lifelong resident of Northern Virginia, Brian has more than twenty-five years of lending experience. After graduating from The Citadel and serving as a Naval Officer, Brian transitioned to the United States Senate Veteran’s Affairs Committee where he served as a Professional Staff Member and had the responsibility of overseeing the VA Loan Guaranty program. After leaving Capitol Hill and the political world, Brian entered the mortgage banking industry. Keeping abreast of the myriad changes in the lending industry over the years has given Brian a unique perspective and the ability to successfully serve his clients regardless of the current market conditions. With his extensive knowledge about the VA and its loan guaranty program, Brian is widely recognized as a specialist in VA financing. He enjoys sharing his knowledge and experience with others, and is licensed in Virginia, Maryland, and Washington, DC.