Mortgage
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Crissinda Ponder
Updated on: April 27th, 2023
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When mortgage rates are on the rise, lenders may offer a mortgage financing technique — known as a mortgage rate buydown — that allows you to pay extra money to get a lower interest rate. A buydown mortgage rate can either be permanent or temporary, and understanding the differences between the two will help you decide if it’s worth the extra expense.
On this page
- What is a mortgage rate buydown?
- How does a buydown mortgage work?
- Different types of mortgage buydowns
- Pros and cons of buying down your interest rate
- How to pay for a mortgage buydown
What is a mortgage rate buydown?
A mortgage rate buydown, which is often called a “buydown mortgage” for short, is a financing arrangement that gives a borrower a lower mortgage interest rate for a certain number of years or for the life of the loan. The borrower pays mortgage points at closing to cover the difference between the standard rate and the lowered rate.
How does a buydown mortgage work?
A mortgage rate buydown can be set up in a number of ways, and the terms are negotiable from lender to lender. However, the structure will vary depending on whether you want a permanent or temporary mortgage buydown rate.
Conventional rate buydowns may cost more in 2023. Fannie Mae and Freddie Mac will assess new fees that could affect the cost of a buydown after May 1, 2023.
- The new credit score benchmark for the lowest conventional rates is 780, which is a 40-point increase from the previous 740 credit score standard.
- Cash-out refinance fees will range from 0.375% to 5.125% of your loan amount, depending on your LTV ratio and credit score.
The following change is scheduled to kick in on Aug. 1, 2023:
- If your DTI ratio is higher than 40%, you may be charged a new fee or a higher interest rate.
How a temporary mortgage rate buydown works
With this option, your rate is lower at first but eventually increases.
- The initial rate is lower for a set time period. Borrowers can choose buydown plans with rates up to 3% lower than current mortgage rates. For example, if market rates are 5%, a 2-1 buydown would allow you to make payments on an initial rate of 3% for the first year.
- The rate goes up each year based on the plan you choose. Rates typically rise by 1% per year for the remainder of the buydown plan. In the 2-1 example above, the rate in the second year would rise to 4%.
- The final rate is fixed for the remaining loan term. In the example above, after the third year, the rate would return to the original market rate of 5%, where it would remain until the loan is paid off.
- The cost of the mortgage rate buydown is paid at closing. You’ll see the charge for the buydown on Page 2 of your loan estimate in the “loan costs” section.
How a permanent mortgage rate buydown works
You’re buying a lower rate for your entire loan term with a permanent mortgage rate buydown.
- The lender offers a lower rate by charging mortgage points. Typically, the more points you pay the more you can reduce your mortgage rate.
- The rate never increases as long as you keep your loan. Unless you take out an adjustable-rate mortgage (ARM), the rate won’t increase for the duration of your loan term.
- The buydown cost is paid at closing. The lender adds the cost of the mortgage rate buydown to your closing costs.
Different types of mortgage buydowns
There are two common types of temporary mortgage buydown options, although lenders offer their own versions. Below is a brief overview of how each works.
3-2-1 BUYDOWN. With this type of buydown, you’re buying a rate that is 3% below the prevailing mortgage rates. Each number represents how much lower the rate is than the current rates.
For example, let’s assume that you’re offered a 3-2-1 buydown at a cost of $12,750, and you’re approved to borrow $425,000 in a market where rates are typically 6% for a 30-year fixed-rate loan.
| Year | Buydown interest rate | Buydown payment | Regular interest rate | Regular monthly payment | Annual savings |
|---|---|---|---|---|---|
| 1 | 3% | $1,791.82 | 6% | $2,548.09 | $9,075.24 |
| 2 | 4% | $2,029.02 | 6% | $2,548.09 | $6,228.84 |
| 3 | 5% | $2,281.49 | 6% | $2,548.09 | $3,199.20 |
| 4-30 | 6% | $2,548.09 | 6% | $2,548.09 | $0 |
To determine if the buydown is worth it, calculate your break-even point by dividing the $18,503.28 in total annual savings from years one through three by the $12,750 in loan costs, which equals 1.45 — or almost one-and-a-half years. If you plan to stay in the home for at least that long, the buydown makes sense.
2-1 BUYDOWN MORTGAGE. This buydown structure works like the 3-2-1, except it only gives you savings for the first two years. Keep an eye on the total costs to make sure you’ll recoup the costs, especially if you only plan to live in your home for a short time period.
Pros and cons of buying down your interest rate
| Pros | Cons |
|---|---|
| You’ll save money on your monthly payment | Your total closing costs will be higher |
| You’ll pay less interest over the life of your loan | Your interest rate and monthly payment could increase |
| You may be able to write off the buydown mortgage costs on your taxes | You could lose your home to foreclosure if you can’t make the higher payment |
| You’ll qualify for a higher loan amount because your interest rate is lower | You’ll deplete cash savings to cover the buydown mortgage expense |
How to pay for a mortgage buydown
There are four ways to pay for a mortgage rate buydown. Here’s how each option works.
Pay cash. If you have an extra stash of cash, you can use it to pay for a lower rate. However, you should make sure that you’ve done the break-even math first.
Ask the seller to pay. Some sellers may try to incentivize you to buy their home by offering to pay for a rate buydown. If they refer you to a “preferred lender” for the mortgage, shop around to make sure you’re getting the best mortgage buydown rate.
Use a builder closing cost incentive. Homebuilders may offer financing incentives if you use their “in-house” mortgage company. You can typically use the funds to cover closing costs, including buying down your rate.
Gift funds. If you’re receiving a gift from family or a close friend, you may be able to apply the gift funds to a mortgage rate buydown.
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FAQs
How do I buy down my interest rate? ›
Mortgage points are the fees a borrower pays a mortgage lender in order to trim the interest rate on the loan, thus lowering the overall amount of interest they pay over the mortgage term. This practice is sometimes called “buying down the rate.” Each point the borrower buys costs 1 percent of the mortgage amount.
What is an example of a 3-2-1 buydown? ›Key Takeaways. With a 3-2-1 buydown mortgage, the borrower pays a lower than normal interest rate over the first three years of the loan. The loan interest rate is reduced by 3% in the first year, 2% in the second year, and 1% in the third year; for example, a 5% mortgage would be just 2% in year one.
Is it worth buying down your interest rate? ›The longer you plan to stay in the home, the better the chances are that buying down the mortgage is financially beneficial. However, if you expect interest rates to go down in the future, you may not need a buy-down, as you'll have the option to refinance instead down the road.
How much does 1 point buy down an interest rate? ›Each mortgage discount point usually costs one percent of your total loan amount, and lowers the interest rate on your monthly payments by 0.25 percent. For example, if your mortgage is $300,000 and your interest rate is 3.5 percent, one point costs $3,000 and lowers your monthly interest to 3.25 percent.
How much is 2 points on a mortgage? ›One mortgage point typically costs 1% of your loan total (for example, $3,000 on a $300,000 mortgage). With this example, if you bought two points, you'd pay $6,000 when your mortgage closes.
How much is 4 points on a mortgage? ›A mortgage point is equal to 1 percent of your total loan amount. For example, on a $100,000 loan, one point would be $1,000. Learn more about what mortgage points are and determine whether “buying points” is a good option for you.
Who qualifies for a 2-1 buydown? ›To get a 2-1 buydown, you must qualify for the mortgage at the full P&I rate. Meaning, you need to qualify based on your ability to pay the actual interest rate. The temporarily lower payments for the first two years do not make mortgage underwriting easier.
What is the average cost of a 2-1 buydown? ›The actual amount you pay depends on the size of your loan, but you can expect to pay an estimated 1% of the loan amount to buy a 0.25%~ reduction of your interest rate.
What are the downsides of 3 2-1 buydown? ›Higher long-term costs: Although payments are lower during the first three years of the loan, the overall cost of the loan may be higher due to the upfront fee and the return to the original interest rate after the buydown period.
What is an example of buying down interest rates? ›Borrowers can choose buydown plans with rates up to 3% lower than current mortgage rates. For example, if market rates are 5%, a 2-1 buydown would allow you to make payments on an initial rate of 3% for the first year. The rate goes up each year based on the plan you choose.
How much is 1 point on a mortgage? ›
A mortgage point equals 1 percent of your total loan amount — for example, on a $100,000 loan, one point would be $1,000.
Will interest rates go down in 2023? ›Realtor.com, Redfin. Real estate marketplace Realtor.com anticipates rates will average 6.4% in 2023, gradually decreasing to 6.1% by the end of the year, according to a mid-year update to its National Housing & Economic Forecast.
Is a 2 1 rate buydown worth it? ›2-1 buydowns can be a good deal for homebuyers, provided that they will be able to afford the higher monthly payments once those begin.
Is it better to put more money down or buy down interest rate? ›If you are buying a home and have some extra cash to add to your down payment, you can consider buying down the rate. This would lower your payments going forward. This is a particularly good strategy if the seller is willing to pay some closing costs.
How much does it cost to buy down interest rate by 2 points? ›You'll generally pay 1% of the total loan amount for each point and receive a 0.25% rate reduction, but the cost and discount vary depending on the market and lender.
Can you buy down interest rate 2%? ›You could potentially save a lot on interest and enjoy a lower monthly payment over the life of the mortgage with a 2/1 buydown. The mortgage gets its name from the fact that the interest rate is 2% lower in the first year, 1% lower in the second year, then goes back to the original interest rate in the third year.
How can I lower my interest rate without refinancing? ›So if you're looking for a better rate on your mortgage, you may have options even if you don't want to or can't refinance. A loan modification, recast or even using strategic prepayments can get you a lower mortgage rate - or at least the equivalent of one.
Can you buy down interest rate later? ›A temporary rate buydown is a mortgage that allows homebuyers to reduce their interest rate for a limited period. The size of the reduction and length depends on the type of mortgage.
How much does 3 2 1 buydown cost? ›For example, a 3-2-1 buydown Conventional 30 year fixed rate loan with a purchase price of $225,000, down payment of 20%, and an annual percentage rate of 6.673% with $3,320.80 in APR fees would result in an interest rate of 3.5% (monthly payment of $808.28) for the first year, 4.5% (monthly payment of $912.03) for the ...