Save Money With a Mortgage Rate Buydown

A second mortgage allows you to obtain a loan, and gives the lender the right to take your property if you fail to repay the money you've borrowed. Africa Studio/Shutterstock

A mortgage is usually the most significant monthly expenditure that people have. The 28 percent rule is that a mortgage makes up about 28 percent of a monthly income. That makes keeping that monthly payment down a priority.

There is a way to temporarily lower a monthly mortgage. A mortgage rate buydown can help. But what is it, how can it be used, and when is it worth it?

Buydown Reduces Interest

Often called a “buydown,” a mortgage rate buydown reduces the mortgage’s interest rate. It requires the homebuyer to pay money upfront to secure this. The buyer also must pay “discount points,” which are an additional closing cost.

A buydown reduces the interest rate for a designated time frame. This can be anywhere from one to three years.

What Does a Buydown Cost?

The cost of a buydown depends on the amount you borrow. Every point the borrower pays is equivalent to 1 percent of the loan amount.

For example, a lender may offer to reduce the borrower’s rate by 0.25 percent in exchange for one point. So, if the borrower is offered an interest rate of 4 percent and is borrowing $400,000, they will pay $4,000 to lower their interest rate to 3.75 percent.

You’re paying to save money.

How Buydown Mortgage Works

Buydowns are negotiated, so they can be structured in a few ways. There are buydowns for the life of the loan, but the most common structures are a 1-0 buydown and a 2-1 buydown. The less common buydown is 3-2-1 buydown.

A 1-0 buydown lowers the interest rate for the loan’s first year. But a 2-1 discounted rate is available for the first two years. After that, the interest rate will increase over the two years until the loan reaches its total percentage rate.

A 3-2-1 buydown lowers the interest rate for the first three years. But it will increase incrementally yearly until it reaches the actual percentage rate.

Who Pays the Buydown Costs?

The borrower could pay the buydown, but that’s not always the case. Sometimes lenders will run promotions that will offer to incur the buydown cost.

Sellers anxious to move their houses will sometimes pay for a buydown. Finally, builders will often take care of the buydown costs. Indeed, 27 percent of builders reported using mortgage rate buydowns to entice buyers.

When to Use a Buydown

A buydown, however, isn’t for everyone. Before using one, future financial plans should be analyzed. For example, a buydown works well if you anticipate increasing your income.

It also works if you can afford the higher future payment but want to save money in the short term.

But if you don’t plan to stay in your new house for at least five years or you plan to refinance quickly, there might not be a lot of savings from a buydown. So, it comes down to considering your future.

Mortgage Rate Buydown Breakeven Point

It’s most beneficial to do a buydown if a seller, builder, or lender offers to pay the discount points for the borrower.

But if the borrower is paying for the buydown, then it’s worthwhile to calculate the breakeven point. This is the amount of time it takes to recoup the cost. The calculation is:

Breakeven point = (the cost of points) / (monthly savings)

Consider your future income and plans to stay in your home when deciding to buydown.

Limits on Buydown Mortgages

Buydowns have some limits. They are only available for purchasing or refinancing a primary residence and second homes.

Investment properties or cash-out refinances are ineligible for buydowns. But you can refinance a buydown if it’s not government-backed. Therefore, Federal Housing Administration loans and U.S. Department of Agriculture loans are not eligible.

Mortgage Buydown Pros

A mortgage rate buydown temporarily reduces your interest rate. So, it can save you money in the short term. But it only saves you interest during the first one to three years, depending on if you go with a 1-0 buydown, 2-1 buydown, or 3-2-1 buydown. Your mortgage will go up to its actual interest rate after this time has passed.

If a seller or builder is willing to pay all or something toward the buydown, you may be able to pay less for a home than the selling price.

A buydown also allows you to ease into higher payments. This is particularly helpful if you’re just starting out.

Mortgage Rate Buydown Cons

After the initial loan period, the mortgage payment increases. This may be difficult if your economic situation has changed and you’re now making less income.

If you can’t pay the increased mortgage payments, you risk foreclosure.

And, finally, the option to a buydown is limited to the type of loan you are offered.

Using a Mortgage Rate Buydown

Interest rates may continue to rise through 2023. The buydown method could protect you against these rate increases. First, look at today’s rates and compare them to what the typical rate is. Then determine if a buydown is economically worth it for you.

The Epoch Times Copyright © 2022 The views and opinions expressed are those of the authors. They are meant for general informational purposes only and should not be construed or interpreted as a recommendation or solicitation. The Epoch Times does not provide investment, tax, legal, financial planning, estate planning, or any other personal finance advice. The Epoch Times holds no liability for the accuracy or timeliness of the information provided.