Mortgage interest rate buydowns serve as an effective strategy for individuals looking to purchase a home, but don’t want, or can’t afford, a 7.5% – 8% interest rate.
So what is a buydown and how can they benefit you? To answer this question, we first must dive into the different types of buydowns and how they differ.
A permanent buydown refers to a reduction in the mortgage interest rate for the entire life of the loan. It’s achieved through the payment of discount points at closing (added to standard closing costs) which are used to cover the cost of the reduced interest rate. 1% in discount points is equivalent to 1% of the loan amount. For example, on a $500,000 mortgage 1 discount point (or 1%) costs $5,000. Purchasing 1% in discount points generally lowers the mortgage rate by approximately ~0.25% (this is not always the case, but a good rule of thumb to keep in mind). This reduction allows for lower monthly mortgage payments throughout the entire life of the loan, making it a favorable option for individuals planning to stay in the home long-term. Permanent buydowns can be utilized with pretty much any loan type at any lender or bank.
Temporary buydowns, on the other hand, provide a short-term reduction in mortgage rates, usually for the first 1 to 3 years of the mortgage term. Most common examples include the 3-2-1 and 2-1 temporary buydowns. For a 3-2-1 buydown, the interest rate is reduced for the first three years, with a 3% reduction in rate for year one, 2% reduction in rate for year two, 1% reduction for year three, and then years four and on the rate reverts to the original market rate from when the mortgage was funded. As an example, a buyer purchasing a home at a 7.5% market interest rate using a 3-2-1 buydown looks like this: Year 1 rate is 3% lower so 4.5%, year 2 the rate jumps to 5.5%, year 3 jumps to 6.5%, and years 4 and on rate increases to that original 7.5%. Similarly, a 2-1 buydown entails a 2% reduction for year one and a 1% reduction for year 2 before reverting to the original rate in the third year. The temporary reduction can significantly lower initial monthly mortgage payments, providing major financial relief in the early years of homeownership.
Temporary buydowns are particularly beneficial for individuals who anticipate an increase of income in the near future, or those who plan on selling or refinancing the home before the interest rate reverts back to the original rate. However, the borrower must be able to qualify for the mortgage at the permanent rate, as the temporarily reduced rate cannot be used for qualification purposes.
Who Can Pay for Buydowns?
Buydowns can be paid for by various parties involved in the home buying process, including the seller, builder, lender, realtor, or buyer. The specifics of who pays for the buydown can often be negotiated during the home buying process. For instance, in many cases, builders or sellers might offer to pay for a temporary buydown as an incentive to attract buyers, especially in a competitive market.
Choosing between a permanent or temporary buydown depends on your individual financial circumstances, long-term homeownership goals, and the specifics of the loan program chosen. It’s imperative to consult with an experienced mortgage advisor to understand the financial implications of both types of buydowns and to determine which option aligns with your homeownership and financial goals.
If you want to learn more about buydowns and other simple ways to reduce the costs associated with buying a home in today’s market, reach out to my team. We will put you on the path to success!
The MT Group