A mortgage rate buydown is a financing strategy borrowers use to reduce the interest rate on their mortgage loans. Sellers start offering it as a concession to reduce the time their houses sit on the market.
The basic idea is that the borrower pays an upfront fee, also known as buydown points, to the lender in exchange for a lower interest rate on their mortgage.
Most traditional buydowns are 1-0, 2-1, and 3-2-1. In the 1-0 buydown, the contract interest rate drops 1% for the first of the loan; in the 2-1 buydown, the rate drops 2% for the first year and 1% for the second year, and in the 3-2-1 buydown, the rate drops 3% for the year, 2% the second year, and 1% the third year.
Adjustable-rate mortgages (ARM) and graduated-payment mortgages are among other types of rate buydowns.
Mortgage Rate Buydown: Explained
Several types of mortgage rate buydowns, including the traditional buydown, the graduated-payment mortgage (GPM), and the adjustable-rate mortgage (ARM) buydown.
The traditional buydown involves paying upfront fees to the lender in exchange for a lower interest rate.
The GPM is a mortgage that starts with a lower payment, gradually increasing over time.
The ARM buydown is similar to the traditional buydown, but the lower interest rate is only temporary, and the rate will eventually adjust to the prevailing market rate. Despite lenders, sellers start offering the traditional buydown to sellers.
Prospective homebuyers, who have been house hunting for months and having many failed offers, welcome the move by sellers.
How Does It Work?
The reduced interest rate is usually fixed for a specified period, after which it adjusts to the prevailing market rate. As stated above, a 2-1 buydown means the rate will drop 2% for the first year and 1% the second year before returning to the contract rate. As of this writing, the average 30-year fixed-rate mortgage rate is 6.44%, according to Bankrate.
A homebuyer will have a contract rate of 4.44% in the first year and 5.4% in the second year, then revert to the contract rate of 6.44 for the rest of the loan.
The monthly principal and interest on $600,000, putting a 20% down payment and pricing at a 6.44% interest rate, is $3,015. The new homeowner will save $7,200 in the first year and $3,696 in the second year.
The advantage of a mortgage rate buydown is that it can lower the monthly mortgage payment, making it easier for borrowers to afford their homes. This can be especially useful for borrowers who expect their income to increase over time or those who need the lower payment to qualify for a loan.
However, buyers need to know that interest might be the same or higher after the second year of the buydown. So, they must ensure they can afford the home at the contract rate.
One of the main benefits of a mortgage rate buydown is that it allows borrowers to lock in a lower interest rate for a set time, providing stability and predictability in their monthly payments.
This can be especially valuable for borrowers who expect interest rates to rise, as the buydown can protect them from paying a higher rate.
It’s important to note that mortgage rate buydowns come with costs, including the upfront fees paid to the lender and the potentially higher interest rate after the buydown period ends.
Borrowers should carefully consider their financial situation and plans before deciding whether a mortgage rate buydown is the right choice for them.
The Bottom Line
A mortgage rate buydown can be a valuable tool for borrowers looking to lower their monthly mortgage payment or lock in a lower interest rate for a set period.
However, it’s essential to consider the costs and benefits before deciding.
As with any financial decision, it’s always a good idea to seek the advice of a professional to help determine if a mortgage rate buydown is right for you.
