Saturday, November 5, 2022 / by Amy Brown
As mortgage rates continue to rise and days on market continue to increase, sellers and some lenders are now offering new programs to encourage buyers to take the leap into home ownership. This is known as a mortgage rate buydown.
What is a mortgage rate buydown?
A buydown is a way for a borrower to obtain a lower interest rate by paying discount points at closing. Discount points, also referred to as mortgage points or prepaid interest points, are a one-time fee paid at closing. In the case of discount points, the interest rate is lower for the loan term.
In an alternate form of buydown, the points purchased reduce the interest rate for a given amount of time at the beginning of the loan. This arrangement is typically paid for through funds escrowed by the seller. Since the interest rate is lower during this time, the borrower’s monthly mortgage payments are more affordable for a time.
How much does it cost to buydown an interest rate?
Each mortgage discount point usually costs 1% of your total loan amount, and lowers the interest rate on your monthly payments by 0.25%. For example, if your mortgage is $300,000 and your interest rate is 6.5%, one point costs $3,000 and lowers your monthly interest to 6.25%.
What type of buydown programs will I see?
Buydowns can be structured in a number of ways but the most common ones that you will see are 1-0, 2-1, and 3-2-1 buydowns. These are temporary rate buydowns where either the seller or the lender pays for the points at closing. How this helps the buyer is by reducing the rate an indicated percentage for 1 year gradually increasing the amount back to the original contracted rate.
For example, a 1-0 buydown reduces the mortgage rate for the buyer by 1% for one year and then returns to the original mortgage rate.
Here's what that looks like for a 30-year fixed with a $400,000 loan amount at a contract rate of 7% interest.
For a 2-1 buydown, the rate decreases by 2% for year 1, 1% for year 2, and then returns to the original mortgage rate.
A $400,000 30-year loan with a standard interest rate of 5%, the buyer would be expected to pay an interest rate of 3% the first year, 4% the second year and 5% from years 3 – 30.
And a 3-2-1 buydown reduces the rate by 3% the first year, 2% the second year, and 1% the third year before returning to the original rate.
How much does this cost the seller?
While the number of points charged for the buydown differs among lenders, the cost of the buydown is roughly equal to the amount the buyer would save in interest.
A buyer may choose to purchase enough discount points to reduce their interest rate evenly over the life of the loan. By obtaining a buydown loan, the buyer pays a larger sum upfront that prevents their interest rate and thus their monthly mortgage payments from ever increasing. By buying down the rate for the entire life of the loan, this rate is usually higher (approximately $16,000-20,000) and is generally not a seller or lender offered incentive.
There are many ways to make homebuying more affordable, even with today's higher interest rates, so give me a call and let's get you referred to a mortgage broker with various programs that make your homebuying dreams come true!