In almost all cases a lender will let you 'buy down' the interest rate with points. When does it make sense?

Buying down an interest rate makes sense only if you're going to keep the mortgage long enough for the savings you gain each month to more than pay for the additional upfront cost of enjoying the lower interest rate. But, last I checked, no one can  predict the future. None of us really knows how long we're going to remain in our home without refinancing. If you're like me, you'll want some sort of 'rule of thumb' to use for determining if taking a lower interest rate is worth the upfront cost. 

First of all, some quick definitions:

• Rate: Interest rate, normally increment by eighths (.125 or 12.5 bps). 

• Fee: The upfront cost (Fee) paid to the lender, if lower than par, in terms of points.

In the case of paying points, we're comparing the cost of the loan today compared to the savings you'll achieve over time. The 'sweet spot' model for rate vs. fee that I use is shown in this number line. I plugged in a par rate of 5.625 as a sample. Use the appropriate par rate at the time you evaluate a sweet spot.

Points (sample):
      1.25    1.0     0.75    0.5     0.25     0
       |       |       |       |       |       |
<============================================ Par ==>
       |   |   |   |   |   |   |   |   |   |   |
    4.375% | 4.625%| 4.875%| 5.125%| 5.375%| 5.625%
          4.5%    4.75%   5.0%    5.25%   5.50%

Generally, when I'm shopping for a customer, I want to find .125 better to the rate for every .25 more to fee (1:2) with a maximum of .375 to fee (1:3). If I'm shopping for rebate pricing, I want to get .500 better to REBATE for every .125 more to RATE (1:4). Occasionally, I can find .75 to REBATE better (1:6). When I find this situation, I call it the "sweet spot"--in fact, a very sweet spot.

If you pay 4 whole points (FEE) to get just 70 basis points better to RATE, that's 1:5.33 and makes the rate an expensive buy, in my opinion. That is, you don't get enough rate reduction for the amount of points you're paying.

This Points Calculator may help you decide.
 

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