Most people who finance a home want manageable mortgage payments, especially during the first few years. And that manageability often relies on obtaining an attractive interest rate. One unique financial tool can help with that: a buydown.
Mortgage Buydowns 101
With a mortgage buydown, a homebuyer can lower their monthly payments with a lower interest rate by putting more money down upfront. Most buydowns apply to the first, second, or third years of the loan, though one can negotiate a buydown for the loan’s life. This extra upfront money goes toward paying discount points, also known as mortgage points, at closing. One discount point costs 1% of the loan amount.
For example, a lender may reduce the borrower’s interest rate by .25% in exchange for one point. So on a mortgage of $500,000 with an interest rate of 6%, buying one point for $5,000 would lower the rate to 5.75%*. It’s not uncommon, especially in a buyer’s market, for sellers and builders to pay the discount points without significantly raising a home’s purchase price.
The most common buydown structures are 1-0, 2-1, and 3-2-1. With a 1-0 buydown, the interest rate is 1% lower for the first year, returning to the regular rate for the rest of the loan. With 2-1 buydowns, the interest rate is 2% lower for the first year and 1% lower for the second. With 3-2-1 buydowns, the initial interest rate is lowered by 3% the first year, 2% the second, and 1% the third.
Pros and Cons of Mortgage Buydowns
On the pro side, a buydown saves you money on monthly payments, freeing up cash for other needs. Over a 30-year mortgage, a buydown could save the borrower thousands of dollars. And the points may qualify for a tax deduction.
On the con side, monthly payments could increase more than expected after the buydown rate ends if the borrower chooses an adjustable-rate mortgage. Some properties, such as manufactured homes and certain investment properties, may not qualify for buydowns.
Who do mortgage buydowns work best for?
First-time homebuyers often use buydowns to ease their way into home ownership. And usually, if they intend to stay in the home for a long time, as buydowns are about saving money on interest in the long run.
Borrowers who have high debt-to-income ratios may benefit from buydowns. The lower initial monthly payments offer some breathing room to pay down debts.
If income is likely to increase over the coming years, as may be the case with young professionals, using a buydown may make sense. If not, higher mortgage payments after the buydown expires could be a struggle.
*For illustrative purposes only. Consult your lender for exact numbers.