What Is a Buydown?A buydown is a mortgage financing technique with which the buyer attempts to obtain a lower interest rate for at least the first few years of the mortgage or possibly its entire life. A 2-1 buydown, for example, is a specific type of mortgage buydown that allows homebuyers to save on their interest rate for the first two years of the loan. Buydowns can also use a 3-2-1 structure as well. Show
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Buydowns ExplainedBuydowns are easy to understand if you think of them as a mortgage subsidy offered by the seller on behalf of the homebuyer. Typically, the seller contributes funds to an escrow account that subsidizes the loan during the first years, resulting in a lower monthly payment on the mortgage. This lower payment allows the homebuyer to qualify more easily for the mortgage. Builders or sellers may offer a buydown option to help increase the chances of selling the property, by making it more affordable. The builder or seller of the property usually provides payments to the mortgage-lending institution, which, in turn, lowers the buyer’s monthly interest rate and, therefore, monthly payment. The home seller, however, usually will increase the purchase price of the home to compensate for the costs of the buydown agreement. TipHomebuyers may choose an adjustable-rate mortgage (ARM) if they plan to refinance once the initial rate term ends or if they plan to sell the property before the rate adjusts. Buydown StructuringBuydown terms can be structured in various ways for mortgage loans. Most buydowns last for a few years, then the mortgage payments increase to a standard rate once the buydown expires. A 3-2-1 and 2-1 mortgage buydown are two common structures lenders can use. 3-2-1 BuydownIn a 3-2-1 buydown, the buyer pays lower payments on the loan for the first three years. For each of the first three years of the mortgage, the buyer’s interest rate would increase incrementally by 1% annually. The full interest rate would apply beginning with the fourth year of the mortgage loan. While the buyer received savings from the lower interest rate in the first three years, the difference in the payments would have been made by the seller to the lender as a subsidy. 2-1 BuydownA 2-1 buydown is structured the same as a 3-2-1 buydown; however, its discount is only available for the first two years. So you would have a 2% interest rate reduction for the first year of the mortgage, then a 1% rate discount for the second year of the mortgage. Your interest rate—and your monthly payments—would increase over time until your loan reaches its actual percentage rate. This happens in year three of the loan. At this point, your monthly mortgage payment would reflect the true loan rate. You would pay up front for the 2-1 buydown at closing, and, theoretically, the money that you save over the first two years would cancel out that payment. ImportantConsider the interest rates for which you’re likely to qualify, based on your credit history and income, to determine if a buydown is worth it. Buydown Pros and ConsWhether it makes sense to use a buydown to purchase a home can depend on several things, including the amount of the mortgage, your initial interest rate, the amount you could save in interest over the initial loan term, and your estimated future income. How long you plan to stay in the home also can come into play for determining your break-even point.
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TipRemember to consider both the up-front costs of buying a home, such as the down payment or closing costs, and the ongoing costs to understand how much you can afford to become a homeowner. Example of a Buydown MortgageHere are some examples of how a buydown mortgage can work. Say you're borrowing $250,000 with a 30-year fixed-rate loan at 6.75%. You can choose between a 2-1 buydown or a 3-2-1 buydown. Here's what the loan breakdown would look like with a 2-1 buydown option:
The buydown fee for this loan would be $5,759. Now, say you choose the 3-2-1 buydown instead. Here's what your loan payments would look like:
Meanwhile,
the buydown fee for this loan increases to $11, 324. So when considering a buydown, it's important to look beyond the initial low payment period to determine whether the costs involved in the near term are worth any interest savings you might realize. When to Use a BuydownA buydown could make sense for buyers if it allows them to get a mortgage without significantly increasing the purchase price of the home or draining their cash reserves. Buydowns also may be more appropriate for people who have stable income set to grow over the life of the loan, making it easier to keep up with payment increases once the initial rate period ends. But again, timing matters. If you don’t plan to stay in the home for at least five years, then you might not see any real savings at all from a buydown. So consider your future plans for buying a home and how long you might stay put before committing to a mortgage buydown. Also, remember that not every mortgage is eligible for a buydown. For example, you can't use them to purchase an investment property or for cash-out refinancing. Government-backed loans, such as FHA loans and USDA loans, also have specific guidelines regarding buydowns and when they can be used. Other Ways to Reduce Mortgage RatesAlternatively, buyers can choose to pay for discount points to buy down their interest rate. In this scenario, the buyer pays money up front to purchase the points, and the lender reduces their interest rate as a result. Discount points can lower the interest rate on a mortgage for the life of the loan, rather than just for the first two years. A buydown is not the same as an adjustable-rate mortgage (ARM), in which the rate is fixed for a set period of time before adjusting to a variable rate. A 5/1 hybrid ARM, for example, has a fixed rate for the first five years, with the rate adjusting annually each year after that, based on the performance of an underlying benchmark rate. Buydown FAQsHow Does a Buydown Work?A mortgage buydown allows a homebuyer to temporarily reduce the interest rate on their home loan for the first few years, in exchange for a few. How Many Points Can You Buy Down on a Mortgage?There's no specific limit on the number of points that someone can buy down on a mortgage. But the number of points an individual buyer may be allowed to buy down can depend on the type of mortgage and the loan terms. Is It Worth It to Buy Down Points?A mortgage buydown could be worth if it you are able to save money on your interest rate during the initial part of the loan term. It's important, however, to consider what you might pay for the buydown fee and how long you plan to stay in the home to gauge your total savings. Can I buy points to lower my interest rate?The per-point discount you'll receive varies by lender, but you can generally expect to get a . 25% interest rate reduction for each point you buy. Most mortgage lenders cap the number of points you can buy. Generally, points can be purchased in increments down to eighths of a percent, or 0.125%.
How do you get interest rates down?Here are seven ways you may be able to decrease your rate and reduce mortgage payments, both at signing and during your loan term.. Shop around. ... . Improve your credit score. ... . Choose your loan term carefully. ... . Make a larger down payment. ... . Buy mortgage points. ... . Rate locks. ... . Refinance your mortgage.. |