Mortgage buydowns have become common over the past few years with the soaring mortgage interest rates in the housing market.
Buying a home is a huge financial decision, and obtaining a mortgage can help you fulfill your needs at large. But let’s not forget that you also have to pay the price for borrowing money – the interest!
Predictions and trends keep going up and down and so do the interest rates. Finding a way to reduce your mortgage interest rate can give you a big relief. Here is where mortgage buydowns can help you considerably if you are willing to put some additional money upfront.
In today’s market, this financing technique is attracting more buyers due to which sellers and builders are ready to fund mortgage buydowns themselves.
So, let’s dive deep into understanding more about mortgage buydowns and help you make an informed decision in your home-buying journey.
What Is A Mortgage Buydown?
A mortgage buydown or buydown mortgage is a financing arrangement that offers a borrower a lower mortgage interest rate for a specific number of years or for the life of the loan. In order to offset the difference between the standard rate and the lower rate, the borrower pays mortgage points at closing.
Mortgage points, which are also known as discount points or prepaid interest points, are nothing but a one-time fee paid upfront.
So basically, in a mortgage buydown, the borrower buys down the interest rate by paying extra cash upfront.
How Much Does A Mortgage Buydown Cost?
The amount that you as a borrower take out on the loan determines how much each discount point will cost. A borrower’s payment of one point equals one percent of the loan amount.
A mortgage lender might, for instance, offer a borrower an option to receive a .30% interest rate reduction in return for one point. Therefore, if they were to obtain a $600,000 mortgage at a 5% interest rate, paying $6,000 (which is 1% of the loan amount) would reduce the borrower’s interest rate to 4.70%.
Who Can Do A Mortgage Buydown?
Usually, it is the borrower (the buyer) who buys down a mortgage and benefits from it. However, sellers and builders too can buy down mortgages for the buyers to attract them by lowering their interest rates.
How Does A Mortgage Buydown Work?
A mortgage buydown can work either on a temporary or permanent basis.
- Temporary Mortgage Buydown
This type of buydown lowers the interest rate for a set period. It means that after the buydown period ends the interest rate will increase each year until it returns to the original rate. - Permanent Mortgage Buydown
In this type of buydown, the mortgage owner buys the interest rate for the entire loan term. For the duration of your loan term, the interest rate won’t rise unless you have obtained an adjustable-rate mortgage (ARM).
Structures Of Mortgage Buydown
In addition to the mortgage buydown for the entire loan term (permanent buydown), the lenders use certain structures to facilitate the temporary buydowns. Although lenders offer their own versions, let’s have a look at some of the common structures below.
- 0-1 Buydown
The interest rate would decrease by 1% during the first year of the loan under this temporary 1-0 mortgage buydown, and it would return to its initial rate in the second year. - 2-1 Buydown
In a 2-1 buydown, the interest rate is lowered by 2% in the first year, 1% in the second, and then goes back to normal in the third year.For example, in the first year, the interest rate on a mortgage with 5.25% would decrease to 3.25%, increase to 4.25% in the second year, and then return to 5.25% in the third year. - 3-2-1 Buydown
This is yet another structure under temporary buydown, your interest would decrease by 3% in the first year, 2% in the second year, and 1% in the third year, after which it would return to the initial mortgage rate.
Benefits Of Mortgage Buydowns
Here’s how buying down mortgage rates can benefit you:
- If you anticipate an increase in your income beyond the first few years of owning a property, a buydown can temporarily lower the monthly interest payment until you are in a more comfortable position to pay the entire amount
- Over the term of your loan, you’ll pay less interest.
- With buydowns builders and sellers can increase the appeal of their offers.
- In order to avoid paying current rates altogether, you may be able to refinance at a lower rate in the future because of a temporary buydown that may delay the full interest payments.
- It can also be a good option for buyers who want to safeguard their cash reserves which could have been affected by the down payment.
Risks Of Mortgage Buydowns
Apart from benefits, there are some risks too that you must consider before you decide to buy down the mortgage rate. These include:
- Both your monthly payment and interest rate could go up in a temporary buydown.
- If you are unable to afford the increased payment, you risk having your property in foreclosure.
- Temporary buydowns may also be problematic if a buyer anticipates refinancing at a cheaper interest rate but the rate doesn’t drop.
- Your overall closing costs will be higher.
- Your savings may be completely depleted to pay for the buydown mortgage cost.
Bottom Line
It could be appealing to take advantage of every opportunity to obtain a lower mortgage rate. However, your interest rate is just one aspect of your mortgage. Keep an eye out for closing costs, since these can completely nullify any savings you may have received from a rate buydown.
Make sure you understand everything about a buydown, including what you stand to gain, how much it will cost, and what you might have to give up in order to obtain it.
Need more profound guidance to ease up your home-buying process? Get in touch with Elite Properties!