Buying a home is a significant financial decision that requires careful consideration of various factors, including the type of mortgage to use. Mortgages are typically repaid over a long period, often ranging from 15 to 30 years, and the interest rate you get can significantly affect the total amount you pay over the loan’s life. To make the mortgage more affordable, some borrowers opt for a buydown. A buydown is a financing technique where a borrower pays an additional amount of money to reduce the interest rate or monthly payment of a mortgage. In this blog post, we’ll explore the two primary types of mortgage loan buy-downs: temporary and permanent.
Temporary buydowns are often used by borrowers who expect to earn more income in the future. With a temporary buydown, the borrower, seller, or home builder pays extra money upfront to lower the interest rate and monthly payment for the first few years of the loan term. After that, the payment will adjust to the original interest rate.
Permanent buydowns, on the other hand, are for borrowers who want a lower interest rate and monthly payment for the entire life of the loan. This is also traditionally known as paying discount points. With a permanent buydown, the borrower pays an additional amount upfront to permanently reduce the interest rate and monthly payment, often by a quarter or half a point. The cost of the permanent buydown will depend on the interest rate, loan amount, and the length of the loan term.
Larry McLane, a loan officer at Sandstone Financial, provides additional insight into buydowns:
“What Is A Buydown On A Mortgage?
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 upfront. 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. The buydown method can be a useful tactic to protect yourself against rate hikes.
How Much Does It Cost To Buy Down An Interest Rate?
The cost for each discount point depends entirely on the amount you, as the borrower, take out on the loan. Each point that a borrower pays is equivalent to 1% of the loan amount.
For example, a mortgage lender may offer a borrower the ability to reduce their interest rate by .25% in exchange for a point. So, if the borrower is obtaining a mortgage for $500,000 and is offered an interest rate of 6.5%, paying $10,000 would lower their interest rate to 6.00%, for the life of the loan.
Who Can Buy Down A Mortgage?
Although it’s the buyer (or borrower) who benefits from a buydown, the buyer isn’t always the one who buys down a mortgage. Sellers and builders can also be responsible for purchasing points to lower the buyer’s interest rate as a sales concession.
Buyers
The majority of buydowns are negotiated between buyers and lenders. Home buyers offer to pay a specific number of points upfront, and in return, they receive a lower interest rate, making their mortgage more affordable for a certain number of years or over the loan term, depending on the buydown structure.
Sellers
Sellers may also offer to buy down a buyer’s mortgage to incentivize the buyer to purchase their home. In these circumstances, the seller will make the one-time payment and deposit it into an escrow account or pay for points over the entire loan term as part of seller concessions.
This payment, or subsidy, provides the lender with the funds necessary to lower the buyer’s interest rate so that the buyer can more easily afford their home loan. However, to make up for this expense, especially in a seller’s market, the seller often will add the cost of the subsidy to the purchase price of their home.
Builders
Like sellers, builders may also offer to pay points to buy down buyers’ mortgages. Typically, a builder will make these upfront payments to entice early buyers to purchase properties in their newly built communities. Once their communities are established, builders are usually less inclined to offer this kind of incentive.
How Buydowns Are Structured
Since buydowns are negotiated, they can be arranged in a variety of ways. In addition to buydowns over the life of the loan, common structures that lenders use are the 1-0 buydown and the 2-1 buydown. A 3-2-1 buydown is less common. However, regardless of the structure, the principles are the same.
The buyer, seller or builder will pay the lender the difference between the standard interest rate and the lowered rate through points at closing. The buyer will benefit from the reduced interest rate until the buydown expires, usually after a few years. Not all buydowns expire. If one does, the buyer will have to pay the standard interest rate for the remainder of the term, which will cause their monthly mortgage payments to increase.
1-0 Buydown
It’s a temporary 1-0 buydown. That means your interest rate is 1% lower than what your contract rate would be for the rest of the loan for the first year. Better yet, it’s free.
Here’s what that looks like for a 30-year fixed with a $500,000 loan amount at a contract rate of 6.25% interest. Cost of the buydown is $3,810.84, which can be paid by either the buyer of seller
| Year | Interest Rate | Monthly Payment | Monthly Savings | Annual Savings |
| 1 | 5.25% | $2,761.02 | $317.57 | $3,810.84 |
| 2 – 30 | 6.25% | $3,078.59 | $0 | $0 |
2-1 Buy-downs
A 2-1 buydown also provides a buyer with a discounted interest rate, but only for the first 2 years of the loan’s term. With this option, the interest rate would be 2% lower the first year and 1% lower the second.
Based on the previous example of a $500,000 30-year loan with a standard interest rate of 6.25%, the buyer would be expected to pay an interest rate of 4.25% the first year, 5.25% the second year and 6.25% from years 3 – 30.
| Year | Interest Rate | Monthly Payment | Monthly Savings | Annual Savings |
| 1 | 4.25% | $2,459.70 | $ | 7,426.69 |
| 2 | 5.25% | $2,761.02 | $317.57 | $3,810.84 |
| 3 – 30 | 6.25% | $3,078.59 | $0 | $0 |
The buyer would save approximately $11,237.53 in interest, so the buyer should expect the total cost of the 2-1 buydown to be the same. As is the case with all temporary buydowns they are beneficial to the buyer only if the seller is paying the cost as a seller concession.
Evenly Distributed Interest Rate Reductions
In some circumstances, 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 an even larger sum upfront that prevents their interest rate and thus their monthly mortgage payments from ever increasing.
Using the same example as above, the buyer would be expected to pay a monthly mortgage payment of $3,078.59 for a zero-point loan, which is a loan without any discount points applied. If the buyer decides they’d rather buy down the mortgage and pay 5.25% interest throughout the loan’s term, their payments would look like this:
| Year | Interest Rate | Monthly Payment | Monthly Savings | Annual Savings |
| 1-30 | 5.25% | $2,761.02 | $317.57 | $3,810.84 |
Because the buyer would be lowering their interest payments for the entire life of the loan – instead of just 2 or 3 years – the total cost of the buydown would be higher. These buydowns usually cost around $16,000 – $20,000 (and save buyers somewhere around $110,000 over the life of the loan), but they only make sense for buyers who intend to stay in the home for more than 5 years or so.
Keep in mind that the amount you’ll save in the initial years of the loan is heavily dependent upon the type of mortgage you’re approved for. Each type is associated with a different mortgage rate, which will directly affect your monthly payment and ultimately your monthly and yearly savings. Knowing this, it’s important to get approved and familiarize yourself with the ins and outs of the loan terms before you consider a buydown.”
Choosing between a temporary and permanent buydown will depend on your financial situation and goals. If you expect to earn more income in the future or plan to sell the property before the temporary buydown expires, a temporary buydown may be a good option. However, if you plan to live in the home for a longer term and want to save on interest payments over the life of the loan, a permanent buydown may be a better option. Be sure to speak with a trusted loan officer who can help you understand the costs and benefits of each option and make an informed decision.
Larry McLane (NMLS#653824, LIC#00980502) has been in the mortgage industry since 1995. Sandstone Financial is affiliated with my brokerage, Surterre Properties, Inc. He can be reached at (949) 545-2710.
If you’d like to speak to The Bond Group regarding buying, selling, or investing in Orange County, California, fill out our Client Intake Form or head to my real estate website, www.the-bond-group.com (DRE#02116840).
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