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How to buy down your mortgage interest rate

How to buy down your mortgage interest rate

If rising mortgage rates are keeping you from buying a home, there is a way to lower your mortgage costs: a buydown interest rate.

With this method, you pay more at closing to lower your mortgage interest rate. While it costs more money upfront, it can lead to greater savings over the life of the loan. But it’s a more beneficial tactic if you plan to stay in the home for a while — the longer you keep the mortgage, the more you’ll save by buying down the rate.

While there are perks to having a lower mortgage rate, there are also factors to consider before buying down your interest rate.

What is buying down your interest rate?

When you buy down your mortgage rate, you pay extra money at closing to purchase points that essentially lower your interest rate.

Different lenders have their own mortgage rate buydown programs, so there might be a slight difference in the calculation and loan terms. Be sure to ask several mortgage lenders how their buydown programs work to help you decide which loan is right for you.

There are two ways to buy down your mortgage. “Discount points” refer to buying down your rate permanently, and a “mortgage buydown” does so temporarily. These two terms both refer to ways to buy down your rate and are often used interchangeably, but there are important differences.

Types of mortgage rate buydowns

There are two main types of mortgage rate buydowns: a permanent or temporary buydown. As implied, the permanent buydown rate lasts for the life of the loan, while the temporary option is only for the first few years or less.

Permanent buydown

With a permanent buydown, the lower rate you purchased with discount points when you first got the mortgage will last for the duration of the loan as long as you don’t refinance the mortgage or change the terms. Permanent buydowns are usually purchased by the homebuyer.

Most lenders will only allow you to buy points for 1% to 2% of the mortgage amount, which typically lowers your rate by 0.25% and 0.50%, respectively. But some will go to 3%, which could lower your mortgage rate by 0.75%.

Temporary buydown

A temporary buydown, or “mortgage buydown,” is when your interest rate is lower for a set period of time — usually one year to three years — then resets to a higher rate for the remainder of the loan.

Temporary buydowns can be paid by the buyer, seller, home builder, or even a lender in some cases. These are usually paid through an escrow account.

With a temporary buydown, the rate typically increases by 1% each year. For example, if market rates are 6%, you could get a temporary buydown in which the rate is 4% the first year, 5% the second year, and then resets to 6% the third year. This is usually called a 3-2-1 buydown.

But there are many other temporary buydown term options, like a 2-1 buydown, in which the rate is staggered lower for the first two years, then resets the third year. Or a 1-0 buydown, in which your rate is 1% lower for only the first year.

In all of these cases, the ideal outcome is that market rates will be lower by the time your temporary rate resets and you’d be able to refinance into that lower market rate. This is betting on future mortgage rates, so be sure you weigh the risks before committing.

It’s important to ask your mortgage lender about any temporary buydown programs because each lender will have different options.

How much does it cost to buy down your interest rate?

The cost to buy down your mortgage rate will vary based on the lender and your total loan amount. But you should plan to have at least several thousand dollars set aside. Keep in mind, this money is in addition to any down payment required on your mortgage and will be paid at closing as part of your closing costs.

In general, one discount point — or 1% of the mortgage amount — equates to roughly a 0.25% reduction in your mortgage rate.

So, let’s say you are offered a $400,000 mortgage with a 7% rate. If you pay $4,000 (which is 1% of your mortgage) to buy a discount point, it could reduce the mortgage rate to around 6.75%. That means you’re lowering your monthly mortgage payment from an estimated $3,028 to $2,961, saving more than $67 a month, excluding the down payment, taxes, and other fees. Over a span of 30 years, you could save more than $24,000 with the lower mortgage rate.

But your savings is based on how long you keep that loan, so it might not be worth it if you plan to sell the house in a few years.

In the case of a temporary buydown, like a 3-2-1, the savings only occurs in the early years. However, it could extend beyond the initial years if market rates are lower by the time the buydown period ends and you can refinance into a lower rate.

Let’s use the same example of a $400,000 mortgage with a 7% rate, resulting in roughly $3,028 a month in mortgage payments. With a 3-2-1 buydown, here’s what you would pay for the first three years:

Year 1: A 4% rate with a $2,276 monthly payment, saving you $752 per month

Year 2: A 5% rate with a $2,514 monthly payment, saving you $514 per month

Year 3: A 6% rate with a $2,765 monthly payment, saving you $263 per month

Based on the monthly estimates, you could save $9,024 the first year, $6,168 the second year, and $3,156 the third year, totaling more than $18,300.

Pros and cons of buying down your mortgage rate

Before paying more upfront to get a lower mortgage rate, consider these advantages and disadvantages of a mortgage rate buydown.

Your monthly mortgage payments will be slightly lower.

You save more in interest over the life of the loan.

If it’s a temporary buydown, you could earn significant savings during the early years of the loan.

You might qualify for a larger mortgage amount if your interest rate is lower because it would reduce your monthly mortgage payments. Lenders approve a total amount based on how much you can afford partly based on your monthly debt-to-income ratio. For example, you might be able to afford a $400,000 loan at a 5% rate because the monthly payments could be about $500 less than the same loan amount at a 7% rate.

Buying down a rate requires cash upfront, so you will have less savings after closing day.

Your closing costs will be higher.

You won’t save as much if you sell the house within a few years than if you stay in the house for a long time, because you might not have time to recoup the extra money you paid at closing for the buydown.

You’ll have higher monthly mortgage costs later if it’s a temporary buydown.

How to pay for a mortgage rate buydown

There are several common ways to pay for a mortgage rate buydown:

  1. Pay more at closing. If you have extra cash after meeting the down payment requirement and other closing costs, you can pay to buy down your rate. Just be sure you don’t totally deplete your savings while moving into your new home. Do the math ahead of time, and check that you can make the monthly mortgage payments after buying down your rate.
  2. Ask the home builder. With new construction homes, some builders will offer to buy down your rate to incentivize you to purchase their home. This may happen if they have their own partner lender, which helps them streamline the entire mortgage and homebuying process together. It can also be the case if they have newly built homes that have sat vacant for a while. If a builder is offering closing cost discounts, ask if that incentive can come in the form of a rate buydown.
  3. Ask the seller. Sometimes, a seller will buy down your rate for you to buy their home. This is a rare case, especially in a seller’s market. However, you can ask for the seller to cover this part of your closing costs when you make an offer on a house or during the negotiation process.***

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