When purchasing a home, one of the most important factors to consider is the mortgage interest rate. A lower interest rate can significantly reduce your monthly payments, making homeownership more affordable.
One way to lower your interest rate is through a mortgage rate buydown. In this guide, we’ll explain what a mortgage rate buydown is, how it works, and provide examples to help you understand the financial impact.
A mortgage rate buydown allows homebuyers to lower the interest rate on their loan for the first few years or for the life of the loan by paying extra upfront, often in the form of discount points. This can make your monthly mortgage payments more affordable, especially in the early years of homeownership.
A discount point is essentially a fee you pay at closing to reduce your interest rate. One discount point typically costs 1% of your loan amount and can reduce your interest rate by approximately 0.25%, though this can vary based on the lender.
There are two common types of mortgage rate buydowns:
Let’s break down each type with examples.
In a permanent buydown, you pay points upfront to reduce your interest rate for the entire duration of the loan.
You want to buy down your interest rate by 0.25% for the life of the loan, which will cost you one discount point, or $3,000.
By paying $3,000 upfront, you save $49 per month and $17,586 in interest over the life of the loan.
Pro Tip: Permanent buydowns make sense if you plan to stay in the home for many years, as the long-term savings can outweigh the upfront costs.
A temporary buydown, such as a 3-2-1 buydown, lowers the interest rate for the first three years of the mortgage. The interest rate starts lower and gradually increases to the full rate in year four.
In the first year, you save $549 per month compared to the full interest rate. In the second year, you save $376 per month, and in the third year, you save $193 per month. After year three, you’ll pay the full mortgage payment of $1,896 for the remainder of the loan term.
Pro Tip: Temporary buydowns are ideal for buyers who expect their income to increase in the near future, allowing them to ease into the full mortgage payment.
To understand the cost-effectiveness of a buydown, it’s essential to calculate the break-even point—the time it takes for the savings from the lower interest rate to cover the upfront cost of buying down the rate.
To find the break-even point:
This means you’ll need to stay in the home for at least 5 years to recoup the upfront cost and begin benefiting from the long-term savings.
In a temporary buydown, the savings are front-loaded, so you see immediate benefits. However, once the interest rate increases to the full rate, the savings stop, so there is no true “break-even” point like with a permanent buydown. You simply benefit from lower payments in the initial years.
In many cases, buyers pay for a mortgage rate buydown. However, it’s also possible for sellers or builders to offer a buydown as an incentive to make the home more affordable for the buyer.
Pro Tip: When negotiating with a seller or builder, ask if they’re willing to cover the cost of a buydown as part of the deal. This can significantly reduce your upfront costs while lowering your monthly payments.
Pros:
Cons:
A mortgage rate buydown can be a useful tool to lower your interest rate and make your home more affordable, but it’s essential to weigh the costs and benefits before committing.
Whether you choose a permanent buydown for long-term savings or a temporary buydown for short-term relief, understanding the math behind the process is crucial to making an informed decision.
