"Should I Pay Points to Lower the Rate?"

Most lenders offer various rates for the same program, with a different number of points associated with each rate. Generally, the lower the interest rate on the loan, the more points you have to pay the lender to “buy down” the rate. If you buy the interest rate down, you will spend money at closing to “buy” a lower monthly payment for the term of the loan. As a general rule, each discount point that you pay at closing lowers the interest rate that the lender can offer by one-eighth to one-quarter point. For example, if an 8% loan is offered at two discount points and you want the rate to be 7.75%, the lender may offer that rate, but only if you pay three to four discount points.

To decide on the best rate and points combination for you, you should consider how long you want to live in the home you’re financing, your available cash and what monthly payment you can afford. You will need to calculate the payback period of buying down the rate, meaning that you should calculate the number of months of a lower payment that you will need to recoup the payment that you made at closing to lower the rate. If you intend to live in the house long enough, buying down the rate may make sense. If you don’t intend to keep the loan for the time necessary to recover the amount you would spend to recover what you spent to buy down the rate, then the additional points may not make sense for you.

You may have another option to consider. Some programs may allow you to include the extra points as part of the loan amount. The downside to rolling in discount points is that it increases the loan amount by the amount of the discount points, which will in turn increase your monthly payment. This may be a good solution if you have limited cash when you close your loan.

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