A rise in interest rates can understandably cause buyers to have concerns about affordability and their monthly mortgage payments. An incremental difference in percentage rate can make all the difference in what hopeful buyers can afford.
Read on to learn more about a financing tool called a buydown, how it works, and whether it’s a good fit for your situation.
Key Takeaways
- Buydowns are a financing tool that benefits buyers by helping them afford payments.
- Buydowns also benefit sellers who are looking for seller concession strategies.
“With a 6% rate instead of 7%, buyers pay about $2,700 less every year on their mortgage. As a result, owning a home becomes affordable to about 1.4 million more renters and 4.3 million more homeowners.” – Nadia Evangelou, Director of Forecasting, National Association of Realtors.
What is a mortgage buydown?
A buydown is a mortgage financing technique where the buyer (borrower) obtains a lower interest rate for at least the first few years of the mortgage or possibly its entire life by paying discount points.
What are discount points?
Discount points, also referred to as mortgage points or prepaid interest points, are a one-time fee paid upfront at closing. Discount points are paid to lower the interest rate for the loan.
In a temporary buydown, the points purchased reduce the interest rate for a given amount of time at the beginning of the loan. Temporary buydowns are typically paid for through concessions / closing costs paid by the seller. Since the interest rate is lower during this time, the borrower’s monthly mortgage payments are more affordable.
What are the common types of temporary buydowns?
- 2-1 buydown reduces the interest rate by two percentage points in the first year, then by one percentage point in the second year, before rising to the full rate for all remaining years of the loan term.
- 3-2-1 buydown reduces the interest rate by three percentage points in the first year, by two percentage points in the second year, then by one percentage point in the third year before rising to the full rate for all remaining years of the loan term.
- 1-1-1 buydown reduces the rate by one percentage point for three years, before rising to the full rate for all remaining years of the loan term.
Who benefits from a mortgage rate buydown?
Although it’s the buyer/borrower who typically benefits from a buydown, they’re not always the one who pays discount points to buy down a mortgage interest rate. Sometimes sellers are responsible for purchasing discount points to lower the buyer’s interest rate.
Buyer Benefits: Temporary buydowns appeal to home buyers in a rising mortgage rate environment and to borrowers who will deplete their savings on the down payment and closing costs. The temporary payment reduction allows borrowers to replenish savings or spend the monthly payment savings on home improvements.
Seller Benefits: Temporary buydowns appeal to sellers who are reluctant to drop the sales price but want a way to entice more buyers. Buydowns are just another type of closing cost or seller concession offered during negotiations to make the transaction work for everyone.
Buydowns are not adjustable rate mortgages (ARMs)
A buydown is not an ARM. Temporary buydowns resemble adjustable-rate mortgages because the borrower starts out making payments at one interest rate and later makes payments at another interest rate. A key difference is what happens with the interest rates. On an ARM, the interest rate and the monthly payments can change periodically for the life of the loan. With a buydown, the interest rate never changes. Instead, the seller (or sometimes the lender) pays part of the borrower’s interest payments in the first year or two or three, but the underlying mortgage rate remains the same.
Example 2-1 buydown math
Let’s say a buyer wants to borrow $400,000 and qualifies for a 30-year mortgage at an interest rate of 7%. A 2-1 buydown would lower their interest rate for the first 2 years, before rising to the full rate for all remaining years of the loan term. The buyer would be expected to pay an interest rate of 5% the first year, 6% the second year and 7% from years 3 – 30.
In this example, the seller would contribute seller paid closing costs to cover the costs of the buydown and entice the buyer to purchase at the agreed upon price. The buyer would benefit from a lower mortgage payment in the first two years. Instead of $2661 a month, the buyer would pay $2147 a month in the first year and $2398 a month in the second year. For a total savings of $9,323 over the first two years before their mortgage payments return to the full amount for the remainder of the loan.
*Seller contribution limits apply in all Buydown Scenarios, ask the lender for specifics.
Get Help Finding a Trusted Lender
Buyers who want to win in a competing real estate market need to know that who they choose for financing is just as important as choosing the best financing tools to help them find their path forward. Reach out to start a conversation with one of our strategic guides. Our team can connect you with trusted lenders to help you gain pre-approval before moving forward with your search plan.
