Learn what it means to “buy down the rate” and if this makes sense for you.

With recent increases in home loan interest rates, there’s a financing term being discussed that many prospective homebuyers aren’t familiar with: points, also known as discount points.

Think of points as prepaid interest

When taking out a home loan, points are paid upfront. In exchange for points, lenders reduce the interest rate. Homebuyers are said to “buy points” or “buy down the rate.”

How points are calculated

One point is equal to 1% of the amount financed. For example, on a mortgage of $200,000, one point costs $2,000. Multiple points can be purchased.

What you gain with points

Generally, a lender will lower the interest rate on home loan by a quarter of a percentage point for each discount point paid. So, if the going rate is 6.25%, buying one point will reduce the interest rate to 6.00% for the life of the loan.

Using our example of a $200,000 loan from above, a 30-year mortgage at 6.25% will cost $1,231 each month, with total interest of $243,319. The same amount financed at 6.00% for 30 years will cost $1,199 each month with total interest of $231,677. If the homebuyer buys one point for $2,000 and keeps the loan for the full 30-year term, the net savings is $9,642. Also, the monthly payment with one paid point is $32 less.

Deciding if points make sense

Buying points can help make monthly payments more manageable and often makes sense if you plan to stay in your home a long time. However, buying points means you’ll need to bring more cash when you close on the loan.

Each situation is different, and you’ll want to analyze how long it will take to make up the cost of points. If you don’t plan to stay in your next home very long, points may not provide you with an advantage. If you’d like help running the numbers, talk to one of our knowledgeable Consumers mortgage loan officers.

Consumers helps members finance land, first and second homes, and home improvement projects each year. We’d love to help you with a mortgage or home equity line of credit; contact us online or call us at 800-991-2221.