How do you "buy" a better rate?

When shopping for mortgage rates, you may be asked if you want to buy down the rate. What this means is that you can pay “points” to obtain a better interest rate. A “point” is equal to one percent (1%) of the loan amount. So, on a $200,000 loan, a point would cost you $2,000. You can pay points in fractional amounts, for instance, ¾ point, 1 ½ points, etc. The amount you pay for points may vary significantly by lender and you should always ask when quoted a rate if it includes any points.

Whether or not you should pay points depends entirely on your own situation and to a great extent on how long you intend on keeping the loan. Your loan counselor can help you determine whether it makes sense to pay points for a lower rate and can help you calculate the number of months it will take to re-coup the upfront outlay of cash. For instance if buying down a rate costs you $2,000 and lowers your monthly payment by $100, it will take 20 months to recover that initial outlay in reduced payments. If you plan on staying in the home longer than that and you have the cash available to buy down, then that may be worthwhile.

There is no standard calculation for determining how many points are necessary to buy down a rate. Each lender differs. One lender may charge 1 point to get a ¼ point lower interest rate, while another may charge only ½ or ¾ point. That is why it is always best to look at the APR (annual percentage rate) that lenders are required to quote along with the interest rate. The APR makes it easier to compare one lender’s rate to another because lenders are required to include the effect of paying points and other fees on the overall cost and rate of the loan.