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What does it mean to buy down a rate?

What does it mean to 'buy down' a mortgage rate?

When you apply for a mortgage and are in the market to buy a home for the first time, the terminology that's often used can sound like a foreign language. Lingo like “DTI" (debt-to-income ratio), "PITI" (principal, interest, taxes and insurance), "loan-to-value ratio," and "amortization schedules" can leave newbies scratching their heads.

While you don't always need to know all of the jargon, your comprehension of certain terms may help you save money. One such phrase to know is "buying down the rate." If you've heard of this before, mortgage points were the most likely subtext.

Otherwise and appropriately known as discount points, mortgage points are fees that come into play during the closing costs portion of a home sale transaction. In essence, mortgage points are upfront origination fees that allow you to "buy down" what you pay in interest over the length of your loan term, which is usually 15 to 30 years.

How much do mortgage points cost?

Generally speaking, one point is equal to 1 percent of the mortgage loan amount.  The more points you buy, the more you spend in origination fees at the closing table.

The upshot is that, by doing so, you may also wind up spending less over the life of your loan because the points you buy go toward reducing how much you spend in interest. You might think of buying down a rate as spending more now in order to save more money down the road.

Does it always make sense to buy down?

Here's the rub when it comes to mortgage buy-downs: They don't necessarily lead to cost savings. What's more, you may not have the available funds to lower your rate. In short, the effectiveness of this strategy varies on a case-by-case basis.

If you're house-hunting and want to get the most bang for your buck, talk to your mortgage loan officer about buying down your rate. Now that the phrase makes sense, your loan officer can help you determine if the strategy makes "cents."