Discount Points vs. Mortgage Buydown: What’s the Difference?

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When mortgage rates increase, so does the cost of borrowing. The good news is that a “mortgage buydown” and “discount points” can lower your rate and help keep your monthly payment within an affordable range.

But how do both options work?

These two terms are sometimes used interchangeably, but it’s important to note that they aren’t the same. Understanding their differences can help you decide the best option for your situation.

What are discount points?

Points can help you save on your mortgage over time. They’re like a “discount” you buy for your interest rate.

To put it simply, when getting a mortgage you can pay extra money upfront to lower your interest rate. As a result, your monthly payment becomes smaller.

Each discount point costs about 1% of the loan and reduces the mortgage rate by 0.25%. Therefore, if you have a $400,000 loan, two points might cost $8,000 and reduce your interest rate from 7.0% to 6.5%. This might seem small, but over time you could save thousands on interest.

Discount points are permanent. With that being said, this option might be a good choice if you plan to own your home for a long time, and you can afford to pay more at closing.

What is a mortgage buydown?

A mortgage buydown, on the other hand, is temporary.

This strategy reduces your mortgage rate for the first few years of your mortgage. This reduction is achieved through either an upfront payment paid by the seller to your lender, or your lender might pay the buydown fee.

One example is a 3/2/1 seller-paid buydown. Under this program, your interest rate is reduced by 3% in the first year, 2% in the second year and 1% in the third year. In the fourth year, you begin paying the original rate for the remainder of the loan term.

FirstBank offers a 1/0 lender-paid buydown, too, where you’re able to enjoy a lower mortgage for the first year of your home purchase.

Both options can make the early years of homeownership more manageable.

Pros of a Temporary Buydown:

  • Initial Affordability: The reduced interest rate in the early years lowers your monthly payments, making homeownership more affordable.
  • Predictable Payments: Your payments are predictable and gradually increase over time.
  • Short-Term Benefits: This option can be useful if you’re planning to sell or refinance within the temporary buydown period.

Cons of a Temporary Buydown:

  • Future Payment Increase: After the temporary buydown period, your interest rate and monthly payments will rise, so it’s important to plan accordingly.
  • Potential Long-Term Cost: While the initial savings can be attractive, your overall cost might be higher.

A temporary buydown may be useful if you expect your income to increase, or if you plan to sell or refinance before the buydown period ends.

Pros of Permanent Discount Points:

  • Long-Term Savings: Paying upfront means you’re able to secure a lower interest rate for the entire loan term.
  • Lower Monthly Payments: A reduced interest rate results in lower monthly mortgage payments.
  • Tax Deductibility: You might be able to write off discount points paid at closing. You should discuss tax benefits with a tax professional.
  • Stability: Your monthly payments remain steady and predictable.

Cons of Mortgage Discount Points:

  • Higher Upfront Costs: Paying for discount points requires an upfront payment, which increases your closing costs.
  • Break-Even Period: It can take several years to recoup the cost of discount points.
  • Risk of Overpayment: If you sell or refinance before breaking even, you won’t fully benefit from the reduced interest rate.

Permanent discount points are ideal if you can afford higher closing costs, and you plan to own your home for an extended period.

Conclusion

The right mortgage strategy can greatly impact your financial journey as a homeowner. To learn more about discount points or a temporary buydown, contact the loan experts at FirstBank Mortgage. Our professionals are available to help you find the right solution.

We’re here to help. Anytime.

Have questions? Contact us for neighborly advice.

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