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Buying Down the Rate: Paying now or paying later

Many lenders will offer a lower interest rate for your loan when the borrower pays a fee up front. The fee is normally paid at closing, but sometimes collected at the time of application or when the rate is locked. The fee is part of how the lender prices mortgage loans to borrowers.

Is this what they call “points”?
Yes. Loan discount points are charged to adjust what the lender earns on the loan. Points typically depend on the general interest rate environment, as well as market conditions in the geographic area in which the lender operates. The fee is based on a percentage of the loan amount. This percentage can change as often as interest rates change. One point equals one percent of the loan amount.

Is paying the discount fee a good deal?
It depends on the amount of the fee in relationship to the how much the rate is discounted. It also depends on how long you plan on being in the house and having the loan. Plus, you’ve got to be able to afford the fee and determine that it isn’t better spent on a larger down payment, or to pay off some other debt. One might even prefer to save the money for a future purchase, like furniture or improvements for your new house.

How are these things calculated?
Lets look at an example for a $100,000 30-year fixed rate mortgage:


Lender ANote RatePointsPayment (P+I)
8.3750.000$760.07
8.2500.125$751.27
8.1250.500$742.50
8.0001.500$733.76

This lender has priced the first .125% rate reduction as only .125% of the loan amount fee. The next reduction costs .375% and jumping to the final reduction will cost an additional 1.00% of the loan amount.

In the first reduction the borrower could save $8.80 a month on a principal and interest payment by selecting the 8.250% rate and paying .125% of the loan amount up front as the discount fee. The fee is calculated by taking the loan amount ($100,000) times the “point” (.125%) which equals $125. One can determine how long it takes to recoup the fee by dividing the fee by the monthly savings ($125.00 / $8.80 = 14.2). Thus it takes just over fourteen months in lower payments to save back in lower payments what was spent up-front in the discount fee. “Buying down the rate” might make sense for the borrower who plans on being in the house and having the loan for more than fourteen months.

Now look at the payment for the 8.000% loan. It’s $26.31 per month lower than the 8.375% payment. The discount fee is 1.500% of the loan amount, which equals $1,500. Working the same calculation as before, $1,500.00 / $26.31 = 57. In this case, a borrower would want to be reasonably sure they will be staying in the house for almost five years in order to recoup the points they bought up-front.

How is the information obtained and when do I lock in a rate?
Though lenders are required to disclose rate and fee information at the time of application, most lenders will answer a potential borrower’s questions about rates and discount points for lower rates.

As far as locking in a rate, lenders vary on policy. Many lenders do not require you to lock in a rate at the time of application. However, know your risks when you do not lock in a rate right away. Rates can go up as well as down. Many borrowers save themselves days of anxiety by locking in early and focusing on other details of their purchase.

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