When it comes to securing a mortgage, most borrowers focus on getting the lowest interest rate possible. However, there are different strategies you can use to adjust your mortgage rate, depending on your financial goals and situation. Two common tactics are buying down the rate through points and buying up the rate, which can reduce upfront costs. Both options offer pros and cons, as does the option of no closing cost refinancing. Let’s break down how each works and when it might make sense for you.
What Does It Mean to Buy Down a Mortgage Rate?
Buying down a rate involves paying discount points upfront in exchange for a lower interest rate on your mortgage. One discount point typically costs 1% of the loan amount and reduces the interest rate by about 0.25%, although this can vary.
For example, if you’re borrowing $300,000 and want to lower your rate from 6% to 5.75%, you might pay $3,000 (1% of the loan amount) upfront as a discount point. The result is lower monthly payments over the life of the loan.
Advantages of buying down a rate:
- Lower monthly payments: The biggest benefit is reducing your monthly mortgage payment by securing a lower interest rate.
- Interest savings over time: With a lower rate, you’ll pay less interest over the life of the loan, potentially saving you thousands of dollars.
- Best for long-term homeowners: If you plan to stay in the home for many years, buying down the rate can make financial sense, as it allows you to maximize long-term savings.
Disadvantages of buying down a rate:
- High upfront costs: Paying discount points requires more cash upfront, which may not be feasible if you’re tight on funds or want to use your cash for other purposes, such as home improvements or investments.
- Takes time to break even: You’ll need to calculate your break-even point—the time it will take for your lower monthly payments to cover the cost of the discount points. If you plan to sell or refinance before hitting the break-even point, buying points may not make sense.
What Does It Mean to Buy Up a Mortgage Rate?
In contrast, buying up a rate means agreeing to a higher interest rate in exchange for reduced or waived closing costs. This strategy is the opposite of buying down the rate. Lenders may offer a lender credit for accepting a higher rate, which helps cover some or all of the closing costs.
For example, if you’re offered a 6% interest rate but opt to take a 6.25% rate, the lender might cover $5,000 in closing costs. This approach can reduce your upfront costs and make it easier to get into a home with less cash out of pocket.
Advantages of buying up a rate:
- Lower upfront costs: If you’re short on cash or prefer to keep more of your savings liquid, buying up a rate can reduce or eliminate out-of-pocket closing costs.
- Flexible for short-term homeowners: If you don’t plan to stay in your home for a long time or expect to refinance in the near future, the higher interest rate may not impact you as much over the short term.
Disadvantages of buying up a rate:
- Higher monthly payments: A higher interest rate means higher monthly mortgage payments, which can add up over the life of the loan.
- More interest paid over time: Even though you save on closing costs upfront, you’ll pay more in interest over the life of the loan, which could outweigh the initial savings.
When Should You Buy Down or Buy Up a Rate?
The decision between buying down or buying up a rate depends on your personal financial situation and how long you plan to stay in the home. Here’s how to decide which option makes sense for you:
- Buy down the rate if:
- You have cash on hand to pay upfront costs.
- You plan to stay in the home for many years (enough time to break even).
- Your priority is minimizing your monthly mortgage payments and total interest paid.
- Buy up the rate if:
- You want to minimize upfront costs and conserve cash for other purposes.
- You expect to sell or refinance the home within a few years.
- Your priority is getting into the home without draining your savings.
No Closing Cost Refinancing: A Middle Ground?
A related concept is no closing cost refinancing, where the lender covers your closing costs in exchange for a slightly higher interest rate. This is essentially a form of buying up the rate, but it applies to refinancing your current mortgage rather than taking out a new one.
How no closing cost refinancing works:
- Instead of paying closing costs upfront (which can range from 2% to 5% of the loan amount), the lender rolls these costs into the loan by increasing your interest rate.
- For example, instead of paying $5,000 in closing costs on a refinance, you may agree to a rate that’s 0.25% higher than the market rate.
Pros of no closing cost refis:
- No large out-of-pocket expenses: This can be ideal if you don’t want to pay closing costs upfront or if you don’t have the cash available.
- Immediate savings on your monthly budget: You can still benefit from refinancing, even without significant upfront expenses.
Cons of no closing cost refis:
- Higher monthly payments: Because the lender recoups the closing costs through a higher interest rate, your monthly payments will be higher than if you paid the closing costs upfront.
- More interest paid over time: While you avoid upfront costs, you’ll pay more in interest over the life of the loan, which can reduce the overall savings from refinancing.
Final Thoughts
When deciding whether to buy down or buy up a mortgage rate—or opt for no closing cost refinancing—it’s crucial to evaluate your financial goals, how long you plan to stay in the home, and how much cash you have on hand. Buying down a rate can save you significant money over time, but only if you stay in the home long enough to justify the upfront costs. Buying up a rate or opting for no closing cost refinancing might be better for those looking to minimize out-of-pocket expenses. In any case, it’s essential to do the math or consult a mortgage professional to understand which option best aligns with your financial situation.