You Can Pay to Lower the Interest Rate on Your Mortgage. Here's How

It's true that home prices are incredibly high these days, and on top of that, interest rates are, too. But if you want to buy a house, you have to pay the interest rates that the bank wants, right?

Absolutely not. And I'm going to tell you how to save yourself a ton of money and not be forced into 6% or 7% interest rates as you shop for a house this year.

Discount points and buying down your interest rate

Until recently, mortgage rates haven't been over 6% since November 2009, so it's not surprising that the idea of discount points has crept into the realm of real estate mythology. No one needed to talk about "buying down a mortgage rate" in the era of cheap lending, so we haven't, and a whole generation of home buyers have gone through the process not even knowing this is an option.

A discount point, otherwise known as a mortgage point, is you literally paying the bank to lower your interest rate. Although one purchased discount point will vary in how much it reduces your interest rate, the impact can be substantial. I checked with a lender local to me and found that this lender offers discount points that amount to a 0.5% reduction in the mortgage rate. So, if you were to get approved by this (or a similar lender) for a mortgage at 6%, and you buy a single point, your actual mortgage rate would only be 5.5%. It's totally legal and everything.

But, of course, you don't have to buy a single point, you can buy two points, or you can buy a half point, or whatever your heart desires. You'll have to pay for these points at closing, as very few lenders will let you roll them into the loan, but they can save you a bundle.

How buying points works out over the longer term

Let's look at mortgage points in the real world, because it's interesting how much you can actually save by spending a little bit upfront.

The median sale price of a home in the United States in the fourth quarter of 2022 was $467,700, according to the Federal Reserve Bank of St. Louis. Let's say we got a little bit of a discount and bought our house for $450,000. The average interest rate for a 30-year fixed-rate mortgage in March 2023 was 6.54%, also according to the St. Louis Fed. We put up a 10% down payment ($45,000) on our conventional mortgage, leaving us to finance $405,000.

If you're borrowing $405,000 at 6.54% on a 30-year term, your principal and interest payment (PI) will be about $2,571 per month. However, if you're borrowing that same amount with a 5.54% interest rate, since you bought two shiny new mortgage points, your payment would be just $2,310 -- just over $261 less each month.

Over five years, those two little points that cost you $8,100 could actually save you over $20,000 in payments. In 10 years, that could turn into almost $40,000 in savings. My point is that it's substantial.

Here's a little chart to make it a bit easier for people who don't like to read math problems:

As you can see, the more points you pay and the longer you hold on to your home and original mortgage, the better the deal gets. No matter how many points you bought in this particular scenario (all scenarios will vary), you'd have saved enough to cover your points cost in a little over two years. Every year after that is a huge bonus for you and your family.

NAR's pre-pandemic data reaching back to 2018 shows that the median homeowner stayed in their home about 13 years. There's no newer data available, but I think it's pretty safe to assume that with higher rates and higher real estate costs, we will see that number climb substantially as people try to make their homes work for them for longer. But, for the sake of this math, let's assume that you stay in your home about 10 years. If you do that, and you've paid for points, you have literally saved yourself anywhere from $10,000 to almost $40,000.

That's "paying for college" money right there -- and a potentially great return on your investment.

When doing the math to see if points are worth it for your loan and financial situation, don't forget to figure in mortgage insurance. If you used money to pay down points that you could have used to build a 20% down payment, there's a chance you could still come out behind. Mortgage insurance varies widely in price, however, and isn't always universally expensive.

Points make it possible to buy a house you love within your budget

Buying a home in these times can be absolutely scream-inducing, and it can make you feel totally defeated. But, if you consider the value you can create by buying points, you may find that the house you've been dreaming of is within your budget.