Mortgage rates took a big leap after the presidential election and are continuing to move higher. Demand for homes is strong, but home prices are hitting new highs and affordability is weakening.
For the average buyer who was thinking about getting into a new home last summer, but didn't, the monthly payment on that same home is now considerably higher. There is, however, a way to lower it by buying down the rate.
"Buying your rate down, or 'paying points,' means you're paying an extra fee on top of standard loan fees like appraisal, underwriting and a credit report to get a lower rate," said Julian Hebron, executive vice president of sales and marketing at RPM Mortgage.
Of course that means you have to have more cash upfront. The math isn't as complicated as it seems. First, a "point" is 1 percent of the amount of your loan, so if you are taking out a $200,000 mortgage, 1 point would be $2,000. Lenders will lower your rate if you pay that point at closing, or, at the start of the loan.
"If you were getting a 30-year fixed loan of $325,000, you might get two options with and without points. Today the option with zero points might show the rate as 4.25 percent, and the option with 1 percent in points — equal to $3,250 — might show the rate as 4 percent," said Hebron. "Paying $3,250 at closing to lower your rate by .25 percent lowers your payment $42 per month, and lowers your interest cost $68 per month."
How do you know if you should buy down the mortgage? It's all about time — how long you expect to be in the home and have that same mortgage. What is the savings? Here comes more math — this time from Matt Weaver, vice president of sales at Finance of America Mortgage.
"We can calculate this figure by taking the dollar value of the buy down and dividing it by the monthly savings from the lower interest rate, then dividing that figure by 12 months. So as an example, let's say our prospective homebuyer will need to pay $2,000 in buy down to generate $30.00/month in savings. If we divide $2,000.00/$30.00, we would conclude it would take 66.7 months, or 5.5 years, to recoup the cost of the buy down — now you can ask yourself, 'Do I reasonably foresee myself staying in this home for at least 5.5 years?' in order to truly capture the return on your investment," explained Weaver.
Sounds simple, if you have the cash and the time, but buying down a mortgage, as with everything else in housing, carries some risk.