How Much Can You Buy Down a Mortgage Rate?

Buying down a mortgage rate involves an upfront payment to the lender to reduce the interest rate on your loan. This strategy aims to lower the overall cost of borrowing and make monthly payments more manageable.

This concept, known as paying “discount points,” influences the long-term expense of a mortgage. While it requires an initial investment, the goal is to secure a more favorable interest rate for the loan’s duration. Deciding to buy down a rate can impact both immediate out-of-pocket costs and future monthly expenditures.

What Mortgage Rate Buy-Down Means

Buying down a mortgage rate involves paying discount points, which are essentially prepaid interest. Each discount point typically costs one percent of the total loan amount. For instance, on a $300,000 mortgage, one point would equate to a $3,000 payment made by the borrower to the lender at closing.

The purpose of these points is to reduce the interest rate applied to the mortgage over its entire term. By paying these fees upfront, borrowers can secure a lower interest rate. This lowered rate directly translates into reduced monthly mortgage payments and potentially significant savings on total interest paid over the life of the loan.

It is important to distinguish discount points from origination points. While both are often referred to as “points” and typically cost one percent of the loan amount, they serve different functions. Origination points are fees charged by the lender for processing and underwriting the loan, and they do not reduce the interest rate. Discount points, conversely, are specifically paid to achieve a lower interest rate.

Factors Determining Buy-Down Potential

Several factors influence how much a borrower can buy down their mortgage rate. Lender policies play a significant role, as individual lenders often impose caps on the maximum number of discount points a borrower can purchase. While there is no universal cap, most lenders generally allow borrowers to buy between one and four points.

Loan program rules also dictate the permissible amount of buy-down.

Loan Program Rules

FHA loans: Requirements generally limit discount points and other fees to a maximum of two percent of the loan amount.
VA loans: Most lenders typically won’t allow more than four points, and only two points can be rolled into a VA Interest Rate Reduction Refinance Loan.
Conventional and Jumbo loans: Allow for the purchase of points, with typical limits ranging from one to three points for conventional and one to four points for jumbo, depending on the lender.

An interest rate floor acts as a practical limit on how low the rate can go, regardless of how many points are paid. This floor represents the minimum interest rate a lender is willing to offer. Even with significant upfront payments, the interest rate will not drop below this predetermined floor.

Market conditions also influence the availability and effectiveness of discount points. The prevailing interest rate environment can affect how much a rate can be reduced per point. The exact reduction in interest rate per point can vary by lender and market conditions, but a common range is typically between 0.125% and 0.25% per point.

Financial Implications of Buying Down

Understanding the financial implications of buying down a mortgage rate involves calculating the upfront cost, the resulting interest rate reduction, and the long-term savings. The cost of points is straightforward: one point equals one percent of the loan amount. For example, on a $400,000 mortgage, one discount point would cost $4,000. If a borrower chooses to pay two points, the upfront cost would be $8,000.

The interest rate reduction achieved per point is a crucial variable, and it is not uniform across all lenders or loan types. While a typical range for interest rate reduction is often cited as 0.125% to 0.25% for each point purchased, the exact figure must be confirmed with the specific lender. For instance, paying two points on a loan might reduce the interest rate from 7.00% to 6.50% if each point reduces the rate by 0.25%.

A lower interest rate directly translates to a reduced monthly mortgage payment. For example, if a $350,000 loan at 7% interest has a monthly payment of $2,328 (principal and interest), and paying two points reduces the rate to 6.5%, the new monthly payment would be approximately $2,211. This results in a monthly savings of $117. Over the full term of a 30-year mortgage, these monthly savings can accumulate to a substantial amount of total interest avoided.

A critical calculation for borrowers is the “breakeven point,” which determines how long it takes for the monthly savings to offset the initial cost of the points. To calculate this, divide the total upfront cost of the points by the monthly savings achieved. Using the previous example, if two points cost $7,000 and save $117 per month, the breakeven point would be approximately 60 months ($7,000 / $117 ≈ 59.83 months), or about five years. After this breakeven period, every subsequent monthly payment represents a net financial gain from the initial investment in points.

Discount points paid on a mortgage for a primary residence are generally considered prepaid interest and may be tax-deductible. The IRS typically allows for the deduction of these points in the year they are paid if certain conditions are met, such as the mortgage being used to buy, build, or improve the home, and the points being a customary practice in the area. For refinances or second homes, points usually must be deducted ratably over the life of the loan. This tax benefit can further enhance the financial attractiveness of buying down a rate for eligible borrowers who itemize deductions.

Deciding Whether to Buy Down Your Rate

Deciding whether to buy down a mortgage rate depends on your specific financial situation and future plans.

Key Considerations

Duration of Homeownership: Buying down a rate offers greater financial benefit if you intend to stay in your home beyond the calculated breakeven point. If you plan to sell or refinance before this point, the initial investment might not be fully recouped.
Upfront Cash Availability: Paying points requires a notable cash outlay at closing, adding to other closing costs. Assess if you have sufficient funds without compromising emergency savings or other financial obligations.
Alternative Uses for Funds: Consider if the money could be invested elsewhere, such as in high-interest savings accounts or other investment vehicles. Alternatively, these funds could pay down high-interest debts, which might offer more immediate and guaranteed savings.
Loan Term: On a shorter loan term, like a 15-year mortgage, the breakeven point might be reached sooner, and total interest savings could be more concentrated. On a longer 30-year term, monthly savings extend over a longer period, potentially leading to greater cumulative savings, provided you remain in the home.