What is a mortgage rate buydown?
There are ways to negotiate your interest rate
Mortgage rates have risen substantially in recent years, causing mortgage payments to skyrocket. According to the Federal Reserve Bank of St. Louis, the average interest rate for a 30-year fixed-rate mortgage was 6.69% on June 15, 2023. Compare that with a 2.96% average rate a little over two years prior.
A homebuyer should at least consider a mortgage rate buydown, which will lower their mortgage rate and monthly payment either temporarily or permanently. But what exactly is a mortgage rate buydown? And is it a good idea for your homebuyer profile?
We’ve reviewed the different types of mortgage rate buydowns, how each works, whom it works best for and how to determine if you should buy down your rate.
- Mortgage rate buydowns offer lower mortgage interest rates, either temporarily or permanently.
- A mortgage rate buydown comes with an upfront cost.
- Homebuyers should check the math of a mortgage rate buydown to determine if it will help them save money in the long run.
How does a mortgage buydown work?
Mortgage rate buydowns and discount points (mortgage points) allow you to lower your mortgage interest rate with an upfront payment when buying a home.
Brian Kimball, a senior mortgage advisor at Waterstone Mortgage, explained: “In most cases, lenders offer different rate options for each loan program. Borrowers can often pick a higher or lower rate on their loan, and the [total] cost associated with the loan will move inversely of the rate. If the rate is higher, the cost is likely to be lower. If the rate is lower, the cost is likely to be higher.”
There are several types of mortgage discount options, including temporary and permanent rate buydowns.
Temporary rate buydowns
- 1-0 buydown: For a 1-0 rate buydown, there’s a 1% rate discount in the first year and a 0% discount in years two and beyond.
- 2-1 buydown: This is a two-year rate buydown with discounts varying each of the first two years. There is a 2% discount in the first year and a 1% discount in the second, then the rate returns to normal for the rest of the loan term. “If the note rate were 7%, then in the first year the rate would be 5%, in the second year the rate would be 6% and in the third year back to 7%,” said Kimball.
- 3-2-1 buydown: As with other temporary rate buydowns, the 3-2-1 buydown refers to the discount applied to each of the first three years of the mortgage loan. In this case, there is a 3% rate discount in the first year, a 2% discount in the second and a 1% discount in the third. The rate returns to normal in years four and beyond.
» MORE: Current mortgage rates
Permanent rate buydowns
Permanent rate buydowns are expressed in “points” and typically cost a percentage of the total loan. For example, a rate discount that costs one point will require paying an additional 1% of the total loan upfront.
This is a good idea for borrowers who plan on keeping the home (and the mortgage) for a long time.
Buydown vs. points
Paying for loan points and getting a permanent rate discount is ideal for buyers who plan on holding onto the home for a long time and don’t plan on refinancing their mortgage.
But the choice is highly dependent on each buyer’s circumstances. “There are advantages and disadvantages of each option, and the best choice depends on the borrower's plans for how long they want to keep the home, how long they want to keep the loan and their financial objectives,” said Kimball.
» MORE: What are mortgage points?
Buydown vs. ARM
ARMs typically offer a five- or seven-year initial fixed interest rate. These are known as “5/1 ARM” and “7/1 ARM” loans. The initial rate is typically lower than average rates for fixed-rate mortgages, but the rate adjustment can be costly, especially if national interest rates rise.
ARMs are usually best for short-term investors or homeowners who plan on refinancing or moving before the rate adjusts. Mortgage rate buydowns can offer permanent rate discounts for long-term investors and homeowners.
Examples of a mortgage buydown
Here are two examples of a mortgage rate buydown:
2-1 mortgage buydown
Sally is buying a home and needs a $300,000 mortgage. The interest rate on a 30-year mortgage is around 7%, and her mortgage payment is around $2,000 per month. To save money for the first few years, she opts for a 2-1 mortgage rate buydown.
Here’s her approximate monthly mortgage payment with the buydown:
- Year one (5% rate): $1,610
- Year two (6% rate): $1,799
- Rest of loan (7% rate): $1,996
The overall amount of savings in the first two years is around $7,000, and the upfront cost of the buydown should be significantly lower than those savings to be justified. Sally will also hope for national rates to decrease after two years, which will give her a great opportunity to refinance.
Two mortgage points
Mark is buying a home and needs a $500,000 mortgage. The interest rate on a 15-year mortgage is around 6%, and his mortgage payment is around $4,200 per month. Mark considers paying for two points to permanently reduce his interest rate for the life of the loan. Each point will cost 1% of his total mortgage and reduce his interest rate by 0.25%.
Here’s his monthly mortgage payment, with and without points:
- Mortgage with points (5.5% rate): $4,169
- Mortgage without points (6% rate): $4,219
- Monthly savings: $50
In this scenario, the overall savings over the life of the loan will be around $9,000, but the total he will pay for his points will be $10,000. His lender needs to offer him either a lower cost per point or a greater interest rate reduction for him to consider paying two points upfront.
Pros and cons of a mortgage buydown
Mortgage buydowns are popular when interest rates are rising and provide relief to buyers who want a more reasonable monthly payment. But they aren’t always worth it, and it’s important to run the numbers to figure out if you’ll save money in the long run.
Here are the pros and cons of a mortgage buydown:
- Buydowns can reduce monthly mortgage payments either temporarily or permanently.
- A buydown can save a homebuyer money over the life of the mortgage.
- A seller may cover a buydown’s upfront cost.
- Buydowns require upfront payment.
- You might not save money over the life of the loan.
- When a temporary buydown expires, payments become much higher.
Should you use a mortgage buydown?
What factors should someone consider when debating a buydown? If you’re in the market to buy a home and are considering a rate buydown, here are a few questions to ask:
- Can you afford it? Rate buydowns cost thousands of dollars upfront, requiring you to bring more cash to the closing table. A way around this is to get the seller to cover the cost.
- How long will you stay with your mortgage and in your home? You might plan to sell your home before the end of your mortgage term, refinance your mortgage within a few years or stay with your mortgage and home through the full term. Considering which direction you’re leaning in will help you determine if it makes sense to go with a temporary rate buydown or to buy mortgage points.
- When, if ever, will you break even? You need to calculate when the savings from your rate buydown break even with the cost of the buydown fees or points. If you don’t keep the mortgage for at least that long, you may lose money.
- Will you manage when rates go back to normal? If you do a temporary rate buydown, make sure you’re prepared for a higher monthly payment once the discounts are gone.
How to get a mortgage buydown
Many lenders offer mortgage buydown options, but upfront costs and rate discounts vary from one lender to the next. You should compare rates and terms from multiple lenders to find the best offer.
Buydown fees will be included as part of the mortgage’s closing costs. You may be able to ask the seller to pay those costs, including the buydown fees, which can save you money on your loan.
Keep in mind that if you go with a temporary rate buydown, you need to qualify for the mortgage at the eventual interest rate rather than the initial discounted rate.
How long does a mortgage rate buydown last?
A mortgage rate buydown can last from one year to the total loan term. Temporary rate buydowns typically last for one, two or three years; permanent rate buydowns last for the entirety of the loan.
Can you cancel or change a mortgage buydown?
No. Mortgage buydown funds are typically kept in an escrow account and paid out to the lender for the duration of the buydown. There are no refunds unless the mortgage is paid in full, in which case the escrow account refunds any remaining funds.
Will a mortgage rate buydown affect my credit score?
No. A mortgage rate buydown is simply prepaid interest on your mortgage and won’t affect your credit score. Your mortgage qualification is also based on your mortgage’s original interest rate, not the discounted rate (unless you’re doing a permanent buydown).
Are there any tax implications with a mortgage buydown?
Mortgage buydowns and points paid by the buyer are generally viewed as prepaid interest and are therefore deductible as an itemized deduction on tax returns. There are several caveats to this general statement, and we recommend meeting with a licensed tax professional to figure out if you qualify for a buydown deduction.
- Federal Reserve Bank of St. Louis, “ 30-Year Fixed Rate Mortgage Average in the United States .” Accessed June 21, 2023.
- Zillow, " Mortgage Calculator ." Accessed June 9, 2023.
- Fannie Mae, " What is required for the treatment of buydown funds? " Accessed June 9, 2023.
- IRS, " Topic No. 504, Home Mortgage Points ." Accessed June 9, 2023.
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