Should I buy-down an interest rate?

First of all, it makes no difference to us whether you buy-down an interest rate or elect a no cost loan. Our job is to assist you in making the best possible decision with respect to selecting a type of loan as well as the interest rate. An excellent starting point is to attempt to estimate how long you anticipate living in the property? If the answer to that question is less than eight years then under no circumstance should you buy down an interest rate since it takes approximately eight years to recoup the cost of the buy-down. Oftentimes borrowers find this not only surprising but somewhat questionable.

This can best be illustrated using the following example.

While there is no exact linear relationship between interest rate and cost, if we had to make the best guess at a linear relationship between the two it would be an 1/8% in rate costs one-half point. This can best be shown by viewing the following abbreviated illustration of a wholesale rate sheet.

Continuing this example let’s compare a $200,000 loan amount with an interest rate of 7.00% and one with a rate of 6.875% (6.875% would cost 1/2 point or $1,000 more than 7.000%).

Given the additional cost of $1,000 to receive the lower rate and the monthly saving of $16.74, the simple payback period would be approximately 60 months or five years ($1,000 / $16.74 = 59.74 mos.). Here, you need to understand the above calculation does not take into consideration the time value of the $1,000 cost for the lower rate. In essence if you elect to pay the $1,000, you lose the ability to invest those dollars. So, in order to take the time value of money into consideration, it is best to include the costs in the amount financed. Hence, the loan balance to get the 6.875% rate would be $201,000 rather than $200,000. Now the numbers are as follows:

Then the payback period, taking into consideration the time value of money, is 98 months or just over 8 years ($1,000 / $10.17 = 98.33 mos.). Once again, if you are not expecting to reside in your property for this period of time you should not be considering an interest rate buy down. Another argument against buying down an interest rate is to recognize that interest rates are cyclical, very cyclical. Here, an evaluation should be made as to the likelihood of lower interest rates in the future. If there is a reasonable likelihood that rates will decline such that a bought down rate today has a reasonable likelihood of being a “no cost” rate in the future a buy down may not be in your best …”interest”. For more information on “no cost” loans, visit “Is there a true no cost loan?” in this section.

Back to Top