With interest rates so low, homeowners are certainly taking advantage of the situation by refinancing their home or purchasing a new home. One of the critical decisions is whether to buydown the interest rate. This mean you pay more upfront at the time you purchase or refinance to have a lower interest rate which leads to a lower monthly payment amount.
Most traditional mortgage companies will try to convince you to buydown the interest rate. This is because they get those fees upfront which makes it more lucrative for them.
But the real answer on what to do depends on the breakeven analysis. You need to compare what the new mortgage is with the higher rate vs the new mortgage with the lower rate. Then take that difference and divide it by the buydown amount. So if you save $100/month and the buydown amount is $4,000, then the breakeven is 40 months.
I personally like the breakeven to be 36 months or less. It is very rare that you will have a mortgage longer than this. Either your life changes and you decide to move, or interest rates drop again and you refi, or the value in your home goes up and your refi to pull money out. All these things could happen in 3 years or less particularly in this current financial environment.
What I like even better is the reverse of a buydown. The really good mortgage brokers will actually have a way for you to cover your closing costs using funds from the lender in exchange for agreeing to a higher interest rate. The math works the same but in reverse. If your monthly payment only goes up by an amount where the payback is 36 months or longer, you take the upfront money from the lender.
I have personally used this 3 times now. It has allowed me to stay flexible in this environment and continue to take advantage of lower interest rates without it costing me any money either on the new loan or the prior loan.
Think of it as a worry free, no regrets refinancing. So next time you are being talked into buying down your interest rate, first run the math, and second ask if you can actually do the reverse by getting a higher interest in exchange for the lender covering your closing costs.