Want a Lower Interest Rate? Try This Strategy

It's possible to save money on your mortgage loan.

With mortgage rates hitting 20-year highs, the monthly payment for a $500,000 home is $1,000 higher than it was for the same loan a year ago. Are you looking for ways to lower your monthly mortgage payments? A mortgage buydown may be the answer.

This strategy allows you to pay a lump sum upfront in order to reduce the interest rate on your mortgage loan and save money over time. Here's how this strategy works and how to decide if it could be right for you.

What is a mortgage buydown?

A mortgage buydown is a way of paying "mortgage points" or "discount points" to get a lower interest rate. By doing this, you lower the interest rate on your loan and get lower monthly payments.

For example, let's say you have a 30-year fixed-rate mortgage with an interest rate of 6% on a $500,000 loan. With a buydown, one point is typically 1% of the loan amount. So paying an additional 2% upfront ($10,000) would reduce your interest rate to 5.5%. This means that instead of paying $3,300 per month for a $500,000 loan, you'd only be paying $3,100 per month. Over time, this could add up to significant savings on your total payments.

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Different types of buydowns

Depending on your lender, you can buy a permanent mortgage buydown, a temporary mortgage buydown, or both. A permanent buydown is when you purchase points for a lower rate that is permanent. A temporary buydown is similar to an adjustable rate mortgage, where your mortgage rate is lower for a certain period of time and eventually increases.

How does it work?

The way a buydown works is that a mortgage lender agrees to give the borrower a lower interest rate in exchange for an upfront payment. This payment may come from any source -- the buyer's own funds, the seller, a closing cost incentive from a home builder, or cash gifts from family and friends. After paying this fee, the lender will then recalculate the remaining balance at a lower rate.

The more money paid upfront, the lower the interest rate will be over time. This strategy can work well if you have the cash available and plan on living in the house for a long period of time. Using our example from above, the breakeven point for putting in the extra $10,000 is about four years and two months.

A mortgage buydown can be an excellent strategy for reducing your monthly mortgage payments and saving money over time. If done correctly, it could significantly reduce your interest rate, and therefore your monthly payments. However, it's important to do your research before deciding whether this is right for you. Run the numbers to make sure this is truly beneficial for both your short- and long-term financial goals.