Improving Your Interest Rate with a Buydown

Improving Your Interest Rate with a Buydown

There is a lot of talk right now about ways to get better mortgage rates for a home purchase with an interest rate buydown, and the popular technique called a 2-1 buydown. Could this be a great solution for you? Let’s begin with a brief discussion of rate buydowns.

An interest rate buy down is when a borrower pays a percentage of the interest on the loan up front in exchange for reducing the interest rate on the loan over the course of its life. So for example, a borrower might pay 1% of the loan (often referred to as a discount point) to "buy down" the interest rate from 6% down to 5.25% for the life of the loan.  The cost of this point may be paid by either the borrower, who is buying the property, or the seller of the property, in order to help the buyer get a more attractive financing rate, and pay a higher price for the property. There are also programs called "2-1 buydowns", where the seller might pay to buy down the interest rate by 2% in the first year, and then the rate adjusts up one percent in the second year, and an additional percentage point in the third year, when it will reach the current market rate.  This allows a buyer to qualify for a more expensive home purchase, and reduces their payments for the first two years, giving them the option to refinance later if the rates become more attractive.  There are also "3-1 buydowns”, where this process unfolds over a 3 year period.

Borrowers should compare the costs and benefits of a 2-1 rate buydown versus a permanent rate buydown in the form of discount points. They should also consider whether they will be able to afford the payments once the rate adjusts up to current market rates. It is always important to focus on the market value of the property, rather than just the payment, and make sure one is not overpaying because they focussed on the lower payment. Often buying down your mortgage interest rate permanently by prepaying some of the mortgage interest upfront can make good sense if you will be holding the property for several years, because you will have a permanently lower monthly payment. A 2-1 buydown is attractive because of the dramatic savings in the first 2 years, and the ability to create a window of time during which you may be able to get a more favorable rate. For a seller who is willing to pay the buy down cost of the buydown, thereby making the buyer's payments more affordable, it can mean selling their property for a higher price.

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