Understanding Mortgage Rate Buydowns: Breakeven Analysis with Points vs. Lender Credits

When comparing mortgage rate options, it’s common to evaluate whether to pay points for a lower interest rate or take a higher rate with lender credits to reduce upfront costs. The decision hinges on how long it takes to break even—where the upfront cost difference is offset by monthly savings and equity growth.

In this analysis, we’ll compare two scenarios:

1. 6.25% interest rate with $4,000 in points.
2. 7.00% interest rate with $5,000 in lender credits.

We’ll calculate the breakeven point and examine how long it takes for the lower interest rate to deliver financial benefits.

Scenario Details

Loan Amount: $400,000

6.25% Rate (With Points):

• Upfront Costs: $4,000 for points.
• Monthly Payment: $2,462.31.
• Monthly Savings: $198.34 compared to the 7.00% rate.
• Extra Principal Payments: Apply the $198.34 savings each month to the loan balance.

7.00% Rate (With Lender Credit):

• Upfront Benefit: $5,000 lender credit applied to closing costs.
• Monthly Payment: $2,660.65.
• No Extra Payments: No monthly savings to apply toward the loan principal.

Key Differences:

• Net Upfront Cost Difference: $9,000 ($4,000 cost at 6.25% vs. $5,000 credit at 7.00%).
• Monthly Savings: $198.34 per month at 6.25%.

Breakeven Analysis

Step 1: Equity Growth at Each Rate

1. At 7.00% (With $5,000 Lender Credit):
   • Higher monthly payment of $2,660.65.
   • Slower equity growth, as more of the payment goes toward interest.
   • Upfront Advantage: The $5,000 lender credit reduces cash-to-close but doesn’t contribute to equity growth.
2. At 6.25% (With Points and Extra Payments):
   • Lower monthly payment of $2,462.31.
   • Savings of $198.34 per month is applied as extra payments to reduce the loan balance.
   • Accelerated equity growth due to extra principal payments.

Step 2: Breakeven Point Calculation

To calculate the breakeven point, we determine how many months it takes for the $9,000 upfront cost difference to be offset by the faster equity growth at 6.25%.

• Monthly Extra Payments at 6.25%:
  The $198.34 savings is applied directly to the principal each month.
  Over 34 months, this totals:
• Equity Growth at 6.25% vs. 7.00%:
  Faster principal reduction at 6.25% leads to increased equity. At 34 months, the cumulative extra payments and faster amortization offset the $9,000 upfront cost difference.

Breakeven Point: 34 months.

Step 3: Long-Term Savings

Once past the breakeven point, the 6.25% rate delivers significant long-term benefits:

1. Lifetime Interest Savings:
   Over a 30-year term:
   • 6.25% Total Interest Paid: ~$382,345
   • 7.00% Total Interest Paid: ~558,036
   • Interest Savings: ~$175,691.
2. Accelerated Loan Payoff:
   By applying the $198.34 monthly savings as extra payments, the loan at 6.25% could be paid off years earlier (294 payments), saving even more in interest.

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Key Takeaways

1. Upfront Costs vs. Long-Term Savings:
   • The 6.25% rate requires $4,000 in points, making the upfront cost $9,000 higher than the 7.00% rate (after factoring in the $5,000 lender credit).
   • However, the monthly savings of $198.34 offsets this cost in 34 months, making the lower rate more beneficial for borrowers planning to stay in the home longer than 3 years.
2. Lender Credit Advantage (7.00%):
   • The $5,000 credit reduces cash-to-close and may appeal to borrowers with short-term horizons who prioritize lower upfront costs.
   • Over time, higher payments and slower equity growth make this option less advantageous.
3. Equity Growth and Accelerated Payoff:
   • The $198.34 savings at 6.25% accelerates principal reduction, building equity faster and shortening the loan term.

Conclusion

For borrowers with a short-term horizon, the 7.00% rate with a $5,000 lender credit offers lower upfront costs. However, for those planning to stay in their loan for 3 years or more, the 6.25% rate with $4,000 in points becomes the better option. With a breakeven point at 34 months, this rate delivers substantial long-term savings, faster equity growth, and the potential for an earlier payoff.

When deciding between mortgage options, consider both your immediate financial situation and long-term goals. A clear understanding of the breakeven point can help you make the most informed choice.

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For a free, real-time quote with no credit checks, visit www.purerate.com/rates, call or text 704.675.7089, or email info@purerate.com.

At Pure Rate, our guiding principle is radical transparency. We earn significantly less on our loans and pass the savings directly on to you. In return, we rely on our satisfied customers to spread the word. This approach allows Pure Rate to reduce marketing expenses and deliver industry-leading savings.

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Disclaimer

This blog is for educational purposes only and should not be construed as financial advice. Mortgage decisions depend on individual circumstances, including income, time horizon, and future plans. To explore how these options apply to your specific situation, consult a licensed loan officer or financial advisor for a detailed analysis.

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