When you apply for a mortgage, many of the factors that determine the interest rate you are offered are, at that point, out of your control. The exception to this is something known as a rate buy down which allows you to take control of your rate and lower your payments.
The best way to buy down your loan rate is through buying discount points. Every mortgage discount point equals 1% of the mortgage amount and reduces your interest rate by 0.25%. This means you can pay a single discount point for $1,000 to lower the 6% rate you are offered on a $100,000 mortgage to 5.75%. You are allowed to buy up to 4 discount points to lower your rate up to one full percentage point, reducing the interest you pay and securing a lower mortgage payment.
A rate buy down may or may not be worth it depending on your situation. The longer you stay in the home, the more it will pay off to buy discount points.
You may be able to roll the cost of the points into your mortgage, but this is not usually a good idea because it lowers the savings you will enjoy (potentially wiping out all savings completely), and it changes your loan-to-value ratio, increasing other loan costs.
A rate buy down is typically a better choice than an adjustable rate mortgage (ARM) that allows negative amortization such as an option ARM, if you plan to remain in your home for a long time.
You have many ways to utilize a rate buy down. A 3-2-1 buy down is popular. This option is a 30-year fixed rate loan with a rate that increases 1% per year for the first three years, and remains fixed for the rest of the loan term. The benefit is you will not pay the full, higher monthly payment for a few years, keeping your payments low if you expect to have a higher income in three years. A 2-1 buy down is another option with an interest rate that increases 1% for the first two years.