Should You Buy Down Your Rate or Put More Money Toward the House?

The question of whether you should buy down your rate or put more money toward the principal comes up often for first-time homebuyers. A friend of mine recently faced this exact question and called to ask for guidance. The truth is, it depends on your goal. Do you want a cheaper monthly mortgage payment, or do you want to reduce how much you borrow?

For my friend, she was hearing different recommendations and was not sure which way to go. Should the extra money be used to reduce the amount she was borrowing, or should it go toward securing a lower interest rate? Both can be smart moves, but they are not the same thing. Putting more money toward the house lowers the amount you borrow. Buying down the rate lowers what the lender charges you to borrow that money. Both can lower your monthly payment, but they get you there differently.

Putting More Money Toward the House

When you buy a home, the amount you borrow from the lender is called the principal. Say you purchase a $325,000 home, put down $25,000 and borrow the remaining $300,000. If you have another $10,000 to put toward the purchase, your loan amount could drop to $290,000. That means you start with a smaller mortgage balance, more equity in the home and less interest to pay over time.

Using a simple 30-year mortgage example, the principal-and-interest payment on $300,000 at 7% would be about $1,996 per month. On $290,000 at the same 7% rate, the payment would be about $1,929. That saves you roughly $67 per month, but notice what did not change: the interest rate is still 7%. You lowered the amount you borrowed, but you did not lower the rate itself.

Putting more money down can also help if it reduces or removes private mortgage insurance, commonly called PMI. PMI is an extra monthly cost that may be required when you put down less than 20% on a conventional mortgage. It protects the lender if you stop making payments. It does not protect your home or your belongings; that is what homeowners insurance is for. Because PMI is added to your monthly payment, a larger down payment may create more savings if it helps you reduce or avoid that cost.

Buying Down the Rate

Buying down the rate means paying more money upfront in exchange for a lower interest rate. This is usually done through discount points. One point equals 1% of the loan amount, so on a $300,000 mortgage, one point would cost $3,000. However, paying one point does not automatically lower your rate by one full percentage point. The amount your rate decreases depends on the lender, the type of loan and market conditions at the time.

For example, a lender may offer you a $300,000 mortgage at 7% with no points, resulting in an estimated principal-and-interest payment of about $1,996. That same lender may offer you a 6.5% rate if you pay $6,000 upfront. At 6.5%, the payment would drop to about $1,896, saving you roughly $100 per month. In this example, the rate buydown creates more monthly savings than putting $10,000 toward the principal, but that does not automatically make it the better option.

You also have to consider how long you expect to keep the mortgage. If the buydown costs $6,000 and saves you $100 per month, it would take 60 months, or five years, to recover what you paid upfront. This is called the break-even point. If you plan to keep the mortgage longer than five years, the buydown may make sense. If you sell or refinance after two years, you may not keep the loan long enough to receive the full benefit.

Which Option Fits Your Goal?

If your goal is to borrow less, build more equity or reduce PMI, putting more money toward the house may be the better choice. If your main goal is a lower monthly payment and you expect to keep the mortgage beyond the break-even point, buying down the rate may make more sense.

There is also a third option that buyers sometimes overlook: keeping some of the money in savings. Buying a home comes with moving expenses, repairs, utility deposits, insurance deductibles and the unexpected expenses that often show up shortly after closing. A lot of new homebuyers tend to overlook these costs. It may not make sense to save $70 or $100 per month on your mortgage if doing so leaves you with no emergency fund.

Before deciding, ask your lender to show you both options side by side. Ask how the extra money would change your loan balance and monthly payment if it went toward the down payment. Ask whether it would reduce or remove PMI. Then ask what rate you could receive by buying discount points, how much those points would cost, how much the payment would decrease and how long it would take to break even.

You do not need to walk into the process already knowing how to calculate every mortgage option. You do need an explanation that makes it clear what each choice is doing with your money.

Putting more money down lowers how much you borrow. Buying points lowers your interest rate. A larger down payment may also reduce PMI. Keeping some money in savings may protect you after closing.

Our goal at She Builds Equity is not to tell you what decision to make. It is

to make sure you understand your options well enough to choose what makes the most sense for your finances, your home and the life you are building.