Rate buydowns provide a way to “buy” a lower interest rate than what the market is currently offering. There are fees involved, but it could be a worthwhile investment if you plan to be in the home for 5 or more years.
Discount points are literally a percentage point of the loan amount. So 1 “point” is equal to 1% of the loan. A $400,000 loan with a discount point of 1% means you would need to bring in an additional $4,000 to closing. A single discount point may only decrease the interest rate by half a percent, so it usually requires purchasing a few discount points to really see a difference in the monthly payment.
The main thing to consider with rate buy-downs is what is referred to as the Break Even Point. As a borrower, it is best to be informed of the drawbacks and to ask yourself - If I pay an additional $10,000 for a lower interest rate, but it will only save $300/month, is this worth it in the long run?
Breakeven Point = (The Cost Of Points) / (Monthly Savings)
$10,000 / $300 = 33.33 months or nearly 3 years to recoup that money.
However, if the rate buy-down will cost, say, $20,000 in order to save $300 a month, it might not be worth it unless you plan to stay in the home for at least 67 months or nearly 6 years.
$20,000 / $300 = 66.67 months or nearly 6 years.
Also, there are some limitations. Borrowers must be qualified for the loan based on the higher, 0-points interest rate. Also, they can only be done on purchases or refinances of principal residences or second homes, and it must be a conventional mortgage, not government-backed. Though there is technically an exception with some FHA purchases.
But, for a home you plan to live in for a long time, rate buy-downs can be a way to lessen the pain of those higher interest rates, and be a real game-changer to save you money over the life of the loan.