When it comes to buying a home, getting the lowest interest rate possible is essential to maximizing your long term and short-term budget. Locking in the lowest interest rate means you pay less interest over the duration of the loan and pay more money towards the principal amount. It’s important for home buyers to fight for the lowest rate, which means paying more out of pocket in order to benefit long term. However, the cost to pay down the interest rate is pretty hefty. Let’s see if the interest rate juice is worth the financial squeeze!
Par Interest Rate
When you ask a lender for an interest rate, they will typically answer by providing a “par interest rate” which is the lowest rate they will offer you without charging you for it. If you lock in a rate lower than the par interest rate, then the lender considers it a loss. If the loan is considered a loss, you end up paying origination or discount points in order for the bank or lender to maintain profitability.
The Five Factors of Buying Down the Rate
The cost is calculated based on five factors:
#1 Your mortgage scenario
Banks and lenders will determine the amount based on risk assessment.
#2 Bank or lender
It’s important to shop your mortgage because all mortgage lenders offer slightly different rates.
#3 Par interest rate
Remember, this is the rate a mortgage lender or bank gives you based on your scenario, risk, cost and commission they need to secure and profit from the loan.
#4 Mortgage points
Mortgage or discount points are what a bank or lender will charge you to give you a rate below their par interest rate. It’s basically a built-in cost the bank charges you to buy down the rate and maintain profitability.
#5 How much the market pays banks to buy the rate that day
Connect with your lender on a weekly basis to see where rates are at. Rates can change by the minute, day or week. You can shop for lower interest rates during the home buying process all the way until you’re in escrow and lock the loan.
How Much Does It Cost Buy Down the Rate?
This depends on the five factors listed above. However, you can get a general idea of how much you might pay by calculating the cost of a mortgage point. Remember, every bank or lender varies with how many points they will charge for giving you an interest rate that’s lower than par. Let’s break down how to calculate the most commonly charged mortgage points.
50 basis points= 0.5%
75 basis points= 0.75%
100 basis points (1 point) = 1%
150 basis points= 1.5%
200 basis points (2 points) = 2%
In order to factor the cost and points together, you will need an exact loan amount on a loan estimate provided by your lender.
Here’s an example scenario:
- Your lender offers you a $400,000 loan amount and a par interest rate at 3.25%.
- You want a 3% interest rate before market rates start to rise.
- Your lender charges 150 basis points (1.5%) for the difference between the par interest rate (3.25%) and the interest rate you want (3%).
- To calculate your out-of-pocket payment, take your loan amount and multiply it by the given basis point percent.
- $400,000 X 1.5% = $6,000 rate charge
Here’s an example for 100 basis points (1%):
- $400,000 X 1% = $4,000 rate charge
Here’s an example for 50 basis points (.5%):
- $400,000 X .5% = $2,000 rate charge
Depending on your loan scenario, your lender will charge you to buy down your rate with mortgage points based on percentage or basis points calculated from your loan amount. Don’t forget to shop your mortgage with different lenders, it’s the easiest way to potentially save thousands of dollars when buying a home!