If you’re shopping for mortgage financing, you’re undoubtedly paying close attention to current interest rates. After all, the rate you pay can make a big difference in your monthly payments and the total cost of the loan. It’s natural to wonder: Can you buy down interest rates?
Fortunately, there are ways to pay extra dollars upfront to lower your rate. Exactly how do you buy down an interest rate, what options are available, what are the pros and cons, and who is a good candidate for a mortgage interest rate buydown? Read on for helpful answers to these and other questions.
What is a buydown?
A mortgage buydown is a way to pay extra money before your loan starts in return for a lower interest rate, either temporarily or permanently, which can decrease your monthly mortgage payment. A buydown is typically paid upfront at closing.
“Buying down the interest rate is a way to lower your monthly mortgage payments for the first few years of the loan or even the entire loan term,” explains Anthony Sharp, a Realtor with Sharp Realty Group in San Antonio. “This approach can make homeownership more affordable and is especially helpful for buyers who expect their income to grow or want lower initial payments.”
While mortgage borrowers typically pay for a buydown, it can also be paid by a home seller, lender, or homebuilder as an incentive to close the real estate transaction.
Dennis Shirshikov, a professor of finance and economics at City University of New York/Queens College, says he’s worked closely with borrowers who have employed buydowns not only to reduce payments but also to manage underwriting thresholds.
“Buydowns can trim the fat – in this case, the debt – off your debt-to-income ratio enough to get your loan approved,” he says.
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Common types of mortgage buydown structures
There are several different ways to pursue a mortgage interest rate buydown. Let’s take a closer look at each option.
1-0Â buydown
With a 1-0 buydown, your interest rate decreases by 1% for the first year only, then jumps back to the original fixed rate. Case in point: If your fixed rate is normally 7.0%, you would pay 6.0% for the first 12 months, then 7.0% for the rest of the loan term.
“On a $300,000 loan, that might save you around $2,000 in year one,” says Ryan Zomorodi, co-founder of Real Estate Skills. “It’s a nice short-term cushion, especially if you’ve got other upfront costs to juggle. But it’s not a game-changer over the long-term.”
The price of a 1-0 buydown is usually close to the amount of total interest saved. A 1-0 buydown is often the buydown option most covered by home sellers as a buyer incentive.
2-1 buydown
Another choice is a 2-1 buydown, which reduces your rate by 2% in the first year and 1% in the second year. By the start of the third year, your fixed rate resets to its normal higher rate.
“Let’s say your permanent rate is 6.5% on a $400,000 loan. With a 2-1 buydown, it will drop to 4.5% in the first year, go up to 5.5% in year two, then go back to 6.5% for the rest of your loan term,” notes Shirshikov. “In this scenario, your savings in year one could be around $530 per month or over $6,300 total. Savings in year two would be about $270 or $3,240 for that whole year. The total cost for the buydown would be around $9,000 to $10,000, including lender fees.”
3-2-1 buydown
Alternatively, you could choose a 3-2-1 buydown, which steps your rate down more gradually: 3% lower in year one, 2% lower in year two, and 1% lower in year three. By year four, you return to the full normal fixed rate.
“This choice saves you the most money upfront, but also costs the most to buy. It can make sense if you’ve got the seller covering this cost or if you are in a high interest rate market and want more time before refinancing,” suggests Zomorodi.
Using that $400,000 loan example at a 6.5% fixed rate, you’d pay only 3.5% in the first year, 4.5% in the second year, and 5.5% in the third year. Your monthly savings could be as high as $670 in year one. But you may pay $15,000 or more for this buydown.
“It appeals primarily to borrowers who intend to refinance or sell before the rate climbs back to its normal high,” adds Shirshikov.
Permanent buydown
If you want to reduce your interest rate for the entirety of your loan term, you can choose a permanent discount point. Each point you purchase is usually equivalent to 1% of the value of your loan, with each point commonly lowering your interest rate by 0.25% (depending on the lender and market conditions). This option is best for those seeking long-term savings.
Going back to the $400,000 loan example at 6.5% interest, if you want to purchase two points you’ll likely pay $8,000, which can get your rate lowered to 6.0%. That 0.5% reduction may not sound like much, but it can save you close to $140 a month, or $50,000 or more over 30 years. You’ll break even on the costs after about five or six years.
“If you’re planning to stay put for the long term, this can be a smart way to lock in savings and avoid future rate hikes that come with other types of buydowns,” continues Zomorodi. “Just be sure the math and your breakeven point makes sense for your needs and expectations.”
Buydown pros and cons
As with any financing option, buydowns have their advantages and disadvantages. Here’s a roundup of both.
Pros
— Lower payments. With a buydown, you can make a larger financial contribution upfront and receive lower monthly payments in return. “Having more manageable monthly payments early on is huge when you are also dealing with moving costs, furnishing a home, and building savings,” Zomorodi says.
— Increased cash flow. “Buydowns can bring some cash flow relief, especially in those early years of homeownership, and can benefit buyers who anticipate earning more in the future, at a time when their rate will increase,” says Shirshikov.
— Easier to qualify. Buydowns enable borrowers to qualify for a mortgage loan and higher borrowing amount more easily by artificially reducing the monthly payment amount at the time at a crucial time – when the loan application is being processed. Check out how Better makes it easier to apply and qualify for a mortgage.
— Flexible options. You have several choices when it comes to buydowns: three temporary buydown options, or you can purchase permanent discount points.
— The seller, lender, or builder may pay for it. In seller’s markets, sellers may be less inclined to lower home prices but more open to offer small buydowns – as the impact of a lower monthly payment can have a more pronounced psychological effect than a home price discount, especially for first-time buyers. If you’re buying new construction, the builder may also sweeten the deal by covering the cost of a buydown.
— Tax deductible. Permanent discount points can be tax deductible in the year paid or if spread over your loan’s term, so long as you meet IRS rules. Temporary buydowns may be deductible within the year you paid for them, although you should consult with a tax expert. Points paid by your lender or seller typically aren’t deductible to you.
Cons
— High costs. The price of a buydown can be thousands of dollars, which must be paid upfront and requires liquidity.
— Financial risk. If you are planning on moving before you break even on costs or realize any savings, or if you refinance too early or too late, you could lose money. If interest rates drop in the near future, refinancing could be a cheaper way to lower payments without the initial cost of a buydown. “There’s also what economists call an opportunity cost; money paid for points could, in theory, be used for other purposes like renovations, emergency savings, or reducing your principal balance,” cautions Shirshikov.
— Delayed sticker shock. If you choose a temporary buydown, you may find it hard to adjust after your interest rate returns to normal, particularly if your earnings have not increased or other expenses have risen.
— Loan complications. Your lender could have restrictions or additional requirements if a buydown is involved, and not every lender or loan program offers buydowns.
Buydown alternatives
If you want to pay less for a mortgage loan, a mortgage buydown isn’t your only option. Instead, consider these other possibilities:
— Make a larger down payment. The bigger your down payment, the less money you need to borrow, which equates to smaller monthly payments and no need to purchase costly points or temporary buydowns.
— Refinance your loan. If you expect rates to decline or you anticipate your credit improving, opting for a higher fixed interest rate now and refinancing your loan later could be a better option than paying for a buydown.
— Opt for an adjustable-rate mortgage (ARM). ARMs offer a lower initial interest rate – which could be even lower than what a 3-2-1 buydown promises – after which time the interest rate can go higher or lower, depending on market conditions. This choice is often better for borrowers who plan on moving or refinancing before the adjustment period starts.
— Request seller or lender credits. Try negotiating with the seller for a price reduction or credit on closing costs, or ask your lender for a credit. “In a buyer’s market, you might be better off asking for seller-paid closing costs or a flat-rate price cut – depending on what your long-term plan is,” recommends Shirshikov.
— Do your homework. Shop around among different lenders and compare rates and terms carefully to find the best deal possible. Also, work hard to improve your credit score, which can result in a lower interest rate.
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Is a buydown for you?
Good candidates for a mortgage rate buydown include buyers with solid incomes who believe their earnings will rise in the next few years, purchasers who expect to remain in their homes for at least a few years, and those who are planning to refinance within a few years. First-time buyers and young professionals who need a cash cushion early on can especially benefit.
“In some cases, savvy investors can use buydowns on rental properties to increase initial cash flow, especially when negotiating with motivated sellers or developers offering incentives,” points out Zomorodi.
It’s also useful for sellers or builders “who want to offer something attractive to buyers without lowering the sales price,” says Sharp. “And it works well in high-interest rate environments in markets where homes are sitting longer.”
To help you determine if a mortgage buydown makes sense for your situation, calculate your breakeven period by simply dividing your expected buydown costs by your annual interest savings. If your breakeven point is longer than the length of time you expect to remain in your home or keep your mortgage loan, a buydown is not recommended – and vice versa.
Case in point: Let’s say your and buydown cost is $4000  your monthly interest savings equates to $70. That computes to an annual savings of $840. Therefore, your breakeven point would be 4.76 years ($4,000 ÷ $840). Put another way, if you think you’ll stay put for a minimum of five years, a buydown could be worth it.
Conclusion
A mortgage buydown is a flexible strategy, one that lets you pay extra upfront to lower your interest rate. This reduces monthly payments either temporarily or permanently. A temporary buydown cuts your rate for the first few years, helping with early costs or loan approval, while a permanent buydown decreases your rate for the entire length of the loan but can cost more upfront. The good news is that sellers, lenders, or builders will sometimes cover these costs.
Buydowns can lower monthly payments immediately but can be expensive upfront and risky if you think you’ll relocate or refinance soon. Instead, consider making a larger down payment, refinancing later, opting for an adjustable-rate mortgage, or pursuing other strategies.
Ready to lock in an interest rate and start your homeownership journey? Better makes it easy to see what you're pre-approved for and offers competitive rates as well as buydown options.
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