You might be able to lower your loan's interest rate by paying more at closing. This is called "buying down" your interest rate. Using discount points, the buydown can change your interest rate for a short time or for good.
Short-term buydowns
The interest rate on a loan is lower for the first two or three years because the borrower pays interest payments ahead of time. The "3-2-1 buydown" is a common type of temporary buydown. It lowers the loan rate by 3% in the first year, 2% in the second year, and 1% in the third year. The main benefit of a temporary buydown is that the borrower may be able to get a bigger loan because the interest rate for the first year is lower. If the borrower expects his or her income to go up, the higher payments in the future may not be a problem.
Buydowns for good
By paying "discount points," borrowers can lower their interest rate for the life of the loan. One discount point is equal to 1% of the loan amount, so for a $100,000 loan, one discount point would cost $1,000. Most of the time, it takes between 4 and 6 discount points to lower the rate by 1%. This can save you money, but it depends on how long it takes you to get back the money you spent on the discount points. Look at the following example to see if this makes "cents" for you:
With no discount points, the rate on a 30-year, $100,000 mortgage will be 7.5%, and the monthly payment will be $699.21. Or, the lender may suggest that you buy two discount points. If you do, the rate will go down by 0.5 percentage points, to 7%. The discount points for this option cost $2,000, and the monthly payment will be $665.30. Each month, $33.91 would be saved. If you divide the price of the discount points by how much you save each month, you can see that it will take 59 months for the points to pay for themselves. If you plan to keep the house for at least 5 years, this is a good choice.
Discount points and buydowns can be great ways to save money, but you need to do your research to make sure it makes money for you and not just for your loan officer.
