How to Buy Down Your Mortgage Interest Rate
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.
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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 You’ll pay less interest over the life of your loan You may be able to write off the buydown mortgage costs on your taxes You’ll qualify for a higher loan amount because your interest rate is lower | Your total closing costs will be higher Your interest rate and monthly payment could increase You could lose your home to foreclosure if you can’t make the higher payment 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.