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Mortgage rates are lower than this time last year, but they’re still nowhere near the 3% range we saw in 2020 and 2021. However, there is a way to lower your mortgage costs: a buydown interest rate.
With this method, you pay more at closing to lower your mortgage interest rate. While it costs more money up front, it can lead to greater savings over the life of the loan. But it’s a more beneficial tactic if you plan to stay in the home for a while — the longer you keep the mortgage, the more you’ll save by buying down the rate.
While there are perks to having a lower mortgage rate, there are also factors to consider before buying down your interest rate.
When you buy down your mortgage rate, you pay extra money at closing to purchase points that essentially lower your interest rate.
Different lenders have their own mortgage rate buydown programs, so there might be a slight difference in the calculation and loan terms. Be sure to ask several mortgage lenders how their buydown programs work to help you decide which loan is right for you.
There are two ways to buy down your mortgage. “Discount points” refer to buying down your rate permanently, and a “mortgage buydown” does so temporarily. These two terms both refer to ways to buy down your rate and are often used interchangeably, but there are important differences.
➡ Read more: See today’s best rates.
There are two main types of mortgage rate buydowns: a permanent or temporary buydown. As implied, the permanent buydown rate lasts for the life of the loan, while the temporary option is only for the first few years or less. Then, there are a few kinds of temporary buydowns.
With a permanent buydown, the lower rate you purchased with discount points when you first got the mortgage will last for the duration of the loan as long as you don’t refinance the mortgage or change the terms. Permanent buydowns are usually purchased by the home buyer.
Most lenders will only allow you to buy points for 1% to 2% of the mortgage amount, which typically lowers your rate by 0.25% and 0.50%, respectively. But some will go to 4%, which could lower your mortgage rate by 1%.
A temporary buydown, or “mortgage buydown,” is when your interest rate is lower for a set period of time — usually one year to three years — then resets to a higher rate for the remainder of the loan.
This type of buydown is usually paid by the seller, the home builder, or even the lender in some cases, and is paid through an escrow account. While buyers can purchase a temporary buydown, it’s more commonly used as a seller concession.
With a 3-2-1 buydown, the rate typically increases by 1% yearly. For example, if market rates are 6.5%, you could get a temporary buydown in which the rate is 3.5% the first year, 4.5% the second year, 5.5% the third year, and then resets to 6.5% the fourth year.
With a 2-1 buydown your rate is lower for the first two years, then resets the third year. With a 2-1 buydown on a 6.5% rate, you would pay 4.5% the first year and 5.5% the second year, then the 6.5% rate would kick in on year three.
Here’s what a payment schedule could look like for a 30-year fixed mortgage loan of $400,000 at 6.5%.
|
Year |
Interest rate |
Monthly payment |
Monthly savings |
Yearly savings |
|---|---|---|---|---|
Source: Prime Lending
With a 1-0 buydown, your rate is 1% lower for the first year and then resets to the normal interest rate for the second year and beyond.
In all these cases, the ideal outcome is that market rates will be lower by the time your temporary rate resets, and you can refinance into that lower market rate. This is betting on future mortgage rates, so weigh the risks before committing.
It’s essential to ask your mortgage lender about any temporary buydown programs because each lender will have different options.
Are you interested in buying a new construction home? Then, you may benefit from a builder buydown. In this case, the builder (not the borrower) pays the lender so the borrower can get a lower interest rate.
Builder buydowns can be either permanent or temporary. Not all builders offer this incentive, but many do, especially as housing markets begin to cool and builders look to offload inventory. According to the American Enterprise Institute, around 64% of new homes sold by larger builders included a permanent buydown. And on average, discounts hovered around 1.3 percentage points. The hope is to entice home buyers who are hesitant to buy due to high interest rates and to offset some of the company’s building costs.
Keep in mind, builder buydowns are for people getting a mortgage to buy a new construction home, not for people building houses with construction loans.
The cost to buy down your mortgage rate will vary based on the lender and your total loan amount. But you should plan to have at least several thousand dollars set aside. Keep in mind, if you’re paying for the buydown, that money is in addition to any down payment required on your mortgage and will be paid at closing as part of your closing costs.
In general, one discount point — or 1% of the mortgage amount — equates to roughly a 0.25% reduction in your mortgage rate.
So, let’s say you are offered a $400,000 mortgage with a 7% rate. If you pay $4,000 (which is 1% of your mortgage) to buy a discount point, it could reduce the mortgage rate to around 6.75%. That would lower a monthly payment of $2,661 to about $2,594, saving about $67 a month, excluding the down payment, taxes, and other fees. Over a span of 30 years, you could save more than $24,000 with the lower mortgage rate.
How much you save, and thus, whether a mortgage rate buydown is worth it, usually depends on how long you plan to keep the original loan.
The up-front cost of discount points can easily be washed away if you refinance too soon. This is where it can be helpful to calculate your break-even point. The break-even point is the total cost of the rate buydown, divided by your monthly savings.
Break-even point (in months): (up-front cost of buydown) / Monthly savings
For a permanent buydown, it’s pretty straightforward. For example, a 1% discount point on a $400,000 30-year fixed-rate mortgage at 7% would cost around $4,000 and save around $67 per month. After 60 months, you will have recouped your up-front costs or hit your break-even point.
Breaking even with temporary buydowns can be trickier because you’re paying up front for short-term savings.
Let’s use the same example of a $400,000 mortgage with a 7% rate, resulting in roughly a $2,661 monthly mortgage payment. With a 3-2-1 buydown, here’s what you would pay for the first three years:
Year 1: A 4% rate with a $1,908 monthly payment, saving you $752 per month
Year 2: A 5% rate with a $2,145 monthly payment, saving you $514 per month
Year 3: A 6% rate with a $2,659 monthly payment, saving you $263 per month
Based on the monthly estimates, you could save $9,024 the first year, $6,168 the second year, and $3,156 the third year, totaling more than $18,300 — however, you’d have to pay around $18,340 to buy the points, which is essentially a wash
This is one reason why buyers are less likely to purchase a temporary buydown and more likely to ask for it as a seller concession
➡ Read more: How much house can I afford? Use our home affordability calculator.
Before paying more up-front to get a lower mortgage rate, consider these advantages and disadvantages of a mortgage rate buydown.
Lowers your monthly payment temporarily or permanently, depending on the type of buydown.
Reduces total interest paid over the life of the loan.
Seller-paid temporary buydowns can drastically lower your payment without requiring you to put up significant cash up front.
Buyer-paid buydowns can increase your closing costs significantly — that’s money that could’ve gone toward a down payment, savings cushion, or other financial goals.
You can lose part of your savings if you sell or refinance before you can recoup your up-front costs.
Once the temporary buydown period ends, the jump to the higher interest rate can strain your monthly budget if you’re not prepared.How to pay for a mortgage rate buydown
There are several common ways to pay for a mortgage rate buydown:
Pay more at closing. If you have extra cash after meeting the down payment requirement and other closing costs, you can pay to buy down your rate. Just be sure you don’t totally deplete your savings while moving into your new home. Do the math ahead of time, and check that you can make the monthly mortgage payments after buying down your rate.
Ask the home builder. With new construction homes, some builders will offer to buy down your rate to incentivize you to purchase their home. This may happen if they have their own partner lender, which helps them streamline the entire mortgage and homebuying process together. It can also be the case if they have newly built homes that have sat vacant for a while. If a builder is offering closing cost discounts, ask if that incentive can come in the form of a rate buydown.
Ask the seller. Sellers are more likely to pay for mortgage discount points as the economy shifts to a buyer’s market. It can help their home stand out from others and may even be preferred to lowering the sale price.
➡ Read more: Seller concessions — An inside look at a powerful real estate negotiating tool
An interest rate buydown on a mortgage is a way to reduce your interest rate — temporarily or permanently — with cash paid up front at closing. Permanent buydowns are done by purchasing discount points, and one point equals a 0.25% reduction in your interest rate.
Discount points typically cost 1% of your total mortgage. For instance, one point on a $300,000 mortgage would cost $3,000 for a 0.25% reduction in your interest rate. Temporary buydowns work a little differently, and you’ll need to go through a mortgage lender with an official buydown loan program.
The maximum number of points a lender will generally allow you to purchase is four, equaling a 1% reduction in your interest rate. However, it could be worth exploring temporary buydown programs that could result in more significant rate reductions for the first few years of your mortgage.
Buying points on a mortgage could be worth it if you plan on staying in your home long enough to recoup what you’ve spent on mortgage points. It could also be worth it to buy points if you have the extra cash, and using it to buy down your rate wouldn’t keep you from achieving other financial goals.
Yes, sellers can purchase a rate buydown on the buyer’s behalf as a seller concession. Concessions are common in buyer’s markets where there are more homes than there is demand. Sellers may advertise concessions with the home, or you can ask in negotiations.
Source: Yahoo Finance
