The decision about whether to refinance is often relatively simple. But the refinance choices that come after that initial decision are the ones that require more research and knowledge. In this post we will be writing about two such choices: The “Buy Down” and the “Float”. Put simply, a “buy down” is when for adding money in fees and/or points you can lower the interest rate your will pay on your mortgage after refinancing. A “float” is when you are allowed to re-lock into a lower interest rate if mortgage rates drop while you are in the refinance process. In both cases you need to assess how much you will save with the lower rate versus the cost of the float or buy down. Is the math as simple as it sounds? Not really.
Now if the difference between what you will save with the float or buy down over the number of years you will live in that home versus the cost is highly significant, you don;t need to read any further. But if the float or buy down provides minimal to moderate savings, you need to know what “Future Value” means. Think of it this way: If you have to pay a large amount of money for anything, in this case a refinance float or buy down, that money cannot be used for anything else and someone else will get the interest on it.
Consider an example with the most basic math: Imagine that the buy down costs you $10,000 in points and fees. You are initially happy because the savings with the buy down will be $11,000 over the ten years you will live in your home. The decision is easy, right? It’s $1,000 better to get the mortgage rate buy down. Not necessarily. Imagine that instead of the buy down you put the same $10,000 into a CD with 3% annual return. Depending on how often the CD compounds, you will likely have around $13,500 when it matures. The future value of your money is actually $13,500.
Often the calculations of future value is much more complicated than that, and it may be worth meeting with a financial advisor if so.