If you are shopping for a mortgage or have ever shopped for a mortgage you have probably heard the term "buying down a mortgage" or "buying down the interest rate." And you probably asked yourself, what in the world does this mean? Luckily, it isn't as complicated as it may first seem. It is important, however, to understand exactly what it means and how it may financially impact you.

What It Means to Buy Down a Mortgage

Your mortgage lender will quote you an interest rate and you will probably hear them say something along the lines of, "On a 30 year fixed the interest rate today is 6.25 percent with a 1 point origination fee and an APR of 6.5 percent." They may go on to say, "Paying 2 points, which is a 1 point origination fee and buying down your mortgage by paying another 1 point, your interest rate would be 6.125 percent with an APR of 6.375 percent."

While this may sound like mumbo jumbo to you, it really just requires that you take a step back and break down what they are saying into segments that you can understand. One point of a mortgage is equal to one percent of the mortgage amount. So in the first scenario you are paying one percent of your mortgage amount to get a rate of 6.25 percent. In the second statement you are still paying the one percent origination fee and you are also buying an additional one percent of your mortgage amount to "buy down" the interest rate on your mortgage by 1/8 of a percent.
 
Example: Sally and Joe Buyer are purchasing a home for $150,000 and would like a mortgage for $100,000. Using the statements above, Sally and Joe Buyer would be paying $1,000 in points to obtain the 6.25 percent rate. They would be paying $2,000 in points to buy down the rate to 6.125 percent.

Should You Do It?

So is it wise to buy down your mortgage? It really comes down to several factors:

1. Your personal financial situation: Do you have enough money in savings to cover your cash down payment, closing costs, and points.
2. How much of a savings are you going to enjoy by buying down the rate? How much money are you really going to save each month in your mortgage payment by paying more in points upfront?
3. What is your break-even point? How long is it going to take you to recoup the additional amount of money that you have pay upfront to buy down your mortgage?
4. Will you have the mortgage long enough to recoup this additional cost?

Example: Using Joe and Sally as an example again, let’s say that Joe and Sally think that they are only going to live in the home for 2 years because after that they are going to start a family and this home isn’t big enough for them to grow into.
 
Paying one point, Sally and Joe’s monthly principal and interest mortgage payment will be $615.72. By paying one additional point Sally and Joe’s monthly principal and interest payment will be $607.61. This means that it is costing Sally and Joe an additional $1,000 (one point buy down) to save $8.11 per month on their mortgage payment.
 
To figure out their break-even point you would divide the additional cost of $1,000 by the savings per month of $8.11. The answer is the total amount of months that it will take Sally and Joe to break-even, which in this case is 123.3 months or 10.28 years.
 
Since Sally and Joe only intend on having the home for about 2 years they will not recoup the additional $1,000 prior to them leaving the home. In this particular situation it is not beneficial for Sally and Joe to buy down their mortgage.
 
Since each situation is different it is important to evaluate your own personal scenario before deciding whether or not it is beneficial to buy down your mortgage. You can also ask your lender to help you conduct a break-even analysis to determine the best option for you.