The Benefits of Buying Down Your Interest Rate on a Loan
In case you haven’t noticed, the Federal Reserve has been systematically and aggressively raising interest rates over the past year or so. That has sent ripple effects through the economy, and most significantly in the real estate sector. As interest rates rise for buyers, it lowers their buying power and makes their monthly mortgage payment go up. That leads to less buyer demand and eventually prices fall.
When you take out a loan, you’re essentially borrowing money from a lender and agreeing to pay them back over time, with interest. The interest rate on your loan is the amount of money you’ll pay the lender for the privilege of borrowing their money. A higher interest rate means you’ll pay more in interest over the life of the loan, while a lower interest rate means you’ll pay less.
One way to lower your interest rate is to buy down your loan. This means paying a lump sum of money upfront, which will lower your interest rate and your monthly payments. You’re basically pre-paying the interest to the lender in exchange for a lower rate. Since most mortgages don’t actually go the full 30 years, this can be a win-win for the lender and the home buyer.
There are a few things to keep in mind if you’re considering buying down your loan:
- The amount of money you’ll save in interest will depend on the size of your loan, the interest rate you’re paying, and the number of points you buy.
- You’ll need to decide whether you want to buy down your interest rate for the entire life of the loan or for a specific period of time.
- Buying down your interest rate will increase your upfront costs, so you’ll need to make sure you can afford the extra money.
There are different programs available. One popular plan is the 3,2,1 Buy down. In the first year of ownership, the interest rate is 3% lower, the 2nd year, it drops to 2% and the third year is 1%. After that the interest rate goes back to the original rate. So this is a temporary buy down.
Other programs buy down the rate for the life of the loan.
In the current market slow down, some buyers have asked the seller to pay for the interest buy down with credits at close in lieu of reducing the purchase price.
If you’re thinking about buying down your interest rate, it’s important to do the math and figure out if it’s the right decision for you. Here are a few of the benefits of buying down your interest rate:
- Lower monthly payments: When you buy down your interest rate, your monthly payments will go down. This can be a big help if you’re struggling to make your monthly payments or if you want to free up some extra cash each month.
- Save money on interest: Over the life of your loan, you’ll save money on interest if you buy down your interest rate. This is because you’ll be paying less interest over time.
- Increase your borrowing power: If you buy down your interest rate, you may be able to qualify for a larger loan. This can be helpful if you’re looking to buy a more expensive home or if you need to borrow money for other purposes.
Of course, there are also some potential drawbacks to buying down your interest rate:
- Upfront costs: As mentioned above, buying down your interest rate will increase your upfront costs. This is because you’ll need to pay a lump sum of money upfront to lower your interest rate unless you can negotiate for the seller to pay with credits at close.
- Longer loan term: If you buy down your interest rate for a specific period of time, your loan term will be extended. This means you’ll be paying off your loan for a longer period of time, which can result in you paying more interest over the life of the loan.
- Opportunity cost: The money you spend buying down your interest rate could be used for other purposes, such as investing or saving for retirement.
Ultimately, the decision of whether or not to buy down your interest rate is a personal one. You’ll need to weigh the pros and cons and decide what’s best for you. If you’re not sure, it’s a good idea to talk to a financial advisor.
There’s quite a few moving parts to financing a home, but it’s wise to know all the tools available to you as a buyer. Buying down your interest rate, especially if the seller does it for you, can save tens of thousands of dollars over the life of the loan.
If your life circumstances have caused you to be thinking about real estate, let’s do a Ron & Don Sit Down and create a custom game plan to help you reach your goals. It’s free, and only takes 45 minutes.