Rates are up .5 percent so far in 2017, and could go higher. This raises the question of whether it makes sense to buy your rate down to control your mortgage costs. Let's review the market outlook, then answer the question.
Where are rates headed from here?
Rates are tied to daily trading in mortgage bonds, and rates rise when bonds sell on improving economic sentiment - this has been happening in 2017.
Concurrently, the Federal Reserve controls short-term rates in the economy using overnight bank-to-bank lending rates. They hike these rates when they believe the economy is improving. Even though mortgage bonds represent longer-term rates, these Fed hikes still fuel selling of mortgage bonds, pushing mortgage rates higher.
The Fed began hiking rates in December, and has indicated continued hiking if economic data stays positive. Their next three rate policy meetings are March 15, May 3, and June 13.
Mortgage rates will rise as the Fed's economic tone becomes more optimistic. The Mortgage Bankers Association calls for rates to rise about 1 percent in 2017 versus 2016, and we've only seen half of that so far.
With many signs pointing to higher rates, let's address the rate buy down question.
What is buying down my rate?
"Buying your rate down" or "paying points" means you're paying an extra fee on top of standard loan fees like appraisal, underwriting, and credit report to get a lower rate.
If you were getting a 30-year fixed loan of $325,000, you might get two options with and without points. Today the option with zero points might show the rate as 4.25 percent, and the option with 1 percent in points - equal to $3,250 - might show the rate as 4 percent.
Paying $3,250 at closing to lower your rate by .2 percent lowers your payment $42 per month, and lowers your interest cost $68 per month.
How do I calculate if I should buy my rate down?
To determine if you should buy down your rate, calculate how long it takes your monthly interest cost savings to repay the cost of the points. In our example, we divide the $3,250 you're paying at closing by the $68 in monthly interest cost savings, showing it takes 48 months for the interest cost savings to repay the points.
If you're going to live in the home longer than four years, then paying the points makes sense. Note, however, that it doesn't make sense if you're getting a 5-year ARM instead of a 30-year fixed - because the 5-year ARM would adjust to a higher payment just one year after you broke even on buying your rate down.
What are the dangers of buying down the rate?
Work with your lender to calculate how long it takes interest cost savings from paying points to repay the points. If you're in the home (or the loan) longer than this breakeven timeline, you won't lose money.
But if rates drop after you pay points, your risk is that you'd need to spend money on a refinance to keep you in the market, but that refinance cost could come during the time you're still waiting to break even on the points you paid.
Given the rate projections noted above, that risk is low for now.
What if I need to buy down my rate to qualify?
Rising rates make your payment higher, which reduces your affordability.
Lenders allow you to spend up to 43 percent of your income on housing and non-housing bills each month. If rising rates don't push you over this threshold and your budget is still manageable, you can proceed.
But if rising rates push you over this qualifying threshold, you don't have to rely solely on buying your rate down to qualify.
You can also reduce your purchase price. Or if you don't want to resort to that, the smartest way to qualify is to find other debt to trim.
How do I know if a rate buy down is being disclosed to me correctly?
Federal law requires lenders to give you a disclosure called a Loan Estimate within three days of a complete loan application.
The Loan Estimate’s second page shows Points in the top left section called Loan Costs. This will show the exact percentage of the loan amount for any points being quoted. It also shows the dollar amount of the points.
Looking for more information about financing a home? Check out our Mortgage Learning Center.
Related:
- When You Should Buy Down Your Interest Rate
- How 2017 Rate Volatility Impacts Home Affordability
- Home Buyers: 5 Things to Know As You Wait for Closing Day
Note: The views and opinions expressed in this article are those of the author and do not necessarily reflect the opinion or position of Zillow.
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