What’s A Mortgage “Buy-Down?”
When you borrow money, there’s a cost for its use. Usually, the cost to borrow money is paid-out over time in the form of interest, say $100,000 at 8 percent.
But, you might also pay 7.75 percent. This can be done with a “buy-down.” Rather than paying 8 percent over the life of the loan, you instead pay some interest up-front at closing in the form of “points.”
For instance, instead of paying 8 percent and no points, you might pay 7.75 percent and 2 points.
In general, since points are a cash cost up front, paying points makes the most sense when you expect the loan to be outstanding for a long time. Points paid for short-term financing can be very expensive.
A practical test works like this:
Suppose your can borrow $100,000 at 8 percent and no points or 7.75 percent and 2 points. If you borrow at 8 percent you have no cost for points. If you borrow at 7.75% you must pay 2 points or, in this example, $2,000 at closing.
The cost for principal and interest for a $100,000 mortgage over 30 years at 8 percent is $733.76 per month. At 7.75 percent, the monthly expense is $716.41 — a savings of $17.35 a month. It will take 115.27 months for savings to equal the cost of points up front ($2,000/$17.35). In this case, it may actually be better to pay the higher interest rate. In addition for taking a long period to recover the $2,000 through monthly savings, a borrower in this situation could take that $2,000 and invest it to off-set monthly mortgage expenses.
In each case, of course, you need to “run the numbers,” to see what makes the most sense in your situation.
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