Shopping for a new home is a pleasant experience, but securing a mortgage may not be as glamorous. You’ll quickly realize the lending process entails several steps, and the true borrowing costs may be far more than you initially imagined. That’s where mortgage rate buy downs come in.
It lets you pay more upfront to lower your interest rate and get more affordable monthly mortgage payments. Plus, you can save a bundle in interest over the loan term. Here’s what you need to know about this option and how to decide if it’s worth entertaining.
What Is a Mortgage Interest Rate Buy Down?
As the name suggests, a mortgage interest rate buy down is a strategy that lets you snag a lower interest rate than you qualify for in exchange for a lump sum of cash. You can do so by purchasing discount points or prepaid interest points.
How Much Does a Mortgage Interest Rate Buy down Cost?
Mortgage discount points typically cost 1% of your mortgage amount. Each point you purchase lowers your rate by 0.25% per point.
To illustrate, assume you get a $400,000 mortgage with a 7% rate. If you buy one point, it will cost you $7,000 and drop your rate to 6.75%.
How a Mortgage Rate Buy Down Works
Here’s a more in-depth look at how rate buy downs work.
Temporary Buy Down vs Permanent Buy Down
With a temporary buy down, you get a lower interest rate for a short initial period—usually the first few years of the mortgage. This can significantly reduce your monthly payment early on. However, after the initial period, the interest rate reverts back to the original rate for the remainder of the term.
By contrast, a permanent buy down reduces your interest rate for the entire length of the mortgage. This involves paying more points upfront, which results in ongoing savings throughout the life of the loan.
Mortgage Buy Down Interest Rate Structure
- 1-0 Buy down: It’s a temporary buy down that reduces your rate by 1% for the first year. You’ll pay the rate in the loan agreement for all subsequent years.
- 2-1 Buy downs: Also a temporary option, it gives you a 2% interest rate reduction in the first year and a 1% reduction in the second year. The rate reverts back to what you were initially offered for the remaining loan term.
- 3-2-1 Buy downs: It gives you a graduated lower rate for the first three years. To illustrate, if your rate is 6%, you will pay 3% in year one, 4% in year two and 5% in year three.
Examples of Mortgage Buy Down
Loan amount: $450,000
Interest rate: 7%
Loan term: 30 years
Structure: 1-0 Buy Down
| Year | Interest Rate | Monthly Mortgage Payment |
| 1 | 6% | $2,697.98 |
| 2-30 | 7% | $2,993.86 |
Structure: 2-1 Buy Down
| Year | Interest Rate | Monthly Mortgage Payment |
| 1 | 5% | $2,415.70 |
| 2 | 6% | $2,697.98 |
| 3-30 | 7% | $2,993.86 |
Structure: 3-2-1 Buy Down
| Year | Interest Rate | Monthly Mortgage Payment |
| 1 | 4% | $2,148.37 |
| 2 | 5% | $2,415.70 |
| 3 | 6% | $2,697.98 |
| 4-30 | 7% | $2,993.86 |
Who Can Benefit from a Mortgage Rate Buy Down
You may find a mortgage rate buy down beneficial if you fit into any of these categories:
- First-time homebuyers: Those entering the housing market may find buy downs appealing as a way to make initial payments more manageable.
- Buyers with limited cash flow: Individuals who expect their income to increase over time can benefit from lower initial payments.
- Investors: Real estate investors might use buy downs to increase cash flow during the early years of property ownership.
- Homeowners looking to refinance: Those refinancing might opt for a buy down to secure lower interest rates and reduce monthly mortgage payments.
- Sellers in a buyer’s market: Sellers can offer buy downs as an incentive to make their property more attractive to potential buyers.
- Builders and developers: To sell homes more quickly, builders may offer buydowns as a marketing tool.
- Borrowers with a short-term ownership plan: If you plan to sell or refinance the home within a few years, a temporary buy down could provide upfront savings.
Buy Down Mortgage Pros and Cons
Pros
- Immediate reduction in interest rates: By paying upfront, you can secure a lower interest rate on your mortgage. This reduced rate translates into more affordable monthly payments for the duration of the buy down period.
- Long-term savings: Although it requires more money at closing, a buy down can potentially save you thousands of dollars over the life of your loan. By locking in a lower rate, you’re paying less in interest with each payment, amounting to considerable cost savings over time.
Cons
- Upfront costs: A mortgage rate buy down requires paying points or fees upfront. This sum is an additional cost on top of your standard closing fees and can be substantial depending on the size of your loan.
- Temporary benefit: Some buy down agreements only offer a reduced rate for a short period spanning one to three years. After this term, your interest rate will revert to the original rate unless you’ve negotiated a permanent buy down, which comes at a higher costs.
Considerations Before Buying Down Interest Rates
Before opting for a mortgage rate buy down, it’s worth analyzing a few key factors to make the right decision for your finances.
Your Financial Situation
Start by assessing if the upfront cost of a rate buy down fits into your budget without compromising other financial goals. Consider if your savings can buffer the expense of buying mortgage points to lower your interest rate.
Your Property and Loan Type
If you have a larger loan amount, each point, which is a percentage of the loan, will cost more, but it could also result in more significant interest savings over time.
Some loan types, like adjustable-rate mortgages, may only offer a rate reduction for the initial fixed period, making points less beneficial in the long run. Due to their riskiness, investment properties often have different point structures compared to primary residences.
Mortgage Buy Down Limits
There are limits to how much you can reduce your mortgage rates. Ask your lender about these limits to decide if a buy down is ideal.
State-Specific Regulations
Be aware of state-specific regulations that may affect the cost and benefits of rate buy downs. Certain states may have unique guidelines or fees pertaining to mortgage transactions that could also impact your decision.
Importance of Market Conditions
Current market conditions greatly influence mortgage rates. Buying down the interest rate when the market forecasts predict stable or declining rates might not yield optimal savings.
Effect of Buy Down Rates on Property Value
While lower mortgage rates can make a property more attractive to buyers, they don’t directly increase the value of your home. Instead, they might facilitate a quicker sale if you decide to move.
Your Mortgage’s Breakeven Point
Calculate the breakeven point. It is where the savings from the reduced payment equals the upfront cost of the buy down. You want to stay in your home long enough to reap the financial benefit of buying down your rate.
How to Buy Down Interest Rates
If you’re interested in buying down your rate, reach out to your lender. They will advise you on your options, the next steps and how to move forward with purchasing discount points. Be mindful that discount points are paid at closing, so you won’t have to hand over cash right away.
FAQs About Mortgage Interest Rate Buy Down
Buying down your interest rate means you pay an upfront fee to secure a lower rate on your mortgage. Doing so could save you a significant amount of money over the life of your loan. However, deciding if it’s right for you depends on your financial situation, how long you plan to stay in the home and the breakeven point.
You can buy down your rate by purchasing mortgage points. Each point costs 1% of your loan amount and lowers your rate by 0.25 rate. So, you’d need four points for a 1% reduction. To illustrate, if you get a $300,000 loan with a 6% rate, you will pay $12,000 ($300,000 * .01 * 4) to lower your rate to 5%.
A 2% interest rate buy down usually refers to a temporary rate reduction where your interest rate is reduced by 2% for the first two years. The rate reverts back to the original percentage for the remaining loan term.
Not all loan types come with rate buy down options. It’s important to consult with your lender to learn more about this option and its availability.
