Buydown Pros and Cons for Home Financing

A buydown can be a great way to lower your monthly mortgage payments, but it's essential to understand the pros and cons before making a decision.

One of the main advantages of a buydown is that it can reduce your monthly payments by thousands of dollars. This can be a huge relief for homebuyers who are on a tight budget.

However, buydowns often come with higher upfront costs, which can be a significant expense for many people. In some cases, the costs can be as high as 2-3% of the purchase price.

Buydowns can also affect your loan terms, often extending the repayment period, which means you'll be paying interest for a longer period. For example, a 30-year loan can become a 35-year loan after a buydown.

Points are a fee paid at closing that reduces the interest rates on a mortgage, typically costing 1 percent of the total loan amount.

Each point can cost a significant amount of money, especially on higher-priced properties. For example, each point on a $200,000 mortgage will cost $2,000, while they’ll cost $4,000 per point on a $400,000 loan.

The amount of interest rate reduction points will lower depends on the lender and your unique circumstances, so it pays to compare offers from different lenders.

The Consumer Financial Protection Bureau recommends asking for the same amount of points from each lender, and points don’t have to be round numbers – you can pay for fractions of a point, such as 1.375 points or 0.125 points.

You can pay for points upfront at closing, or roll the cost into the mortgage loan, but adding the cost of points to the mortgage means you will also pay interest on them for the life of the loan.

Buying down an interest rate can be a smart move for homebuyers. Each point costs 1% of the loan amount and usually lowers the interest rate by about 0.25%.

For a $200,000 mortgage, buying four points would cost $8,000, which can result in a net savings of $92,000 over 30 years. This is because buyers will spend more than $92,000 less on interest over 30 years than they would otherwise.

The process of buying down a rate involves handing over the fees, along with your down payment, at the closing table. This is usually done when buying mortgage points, but other parties like sellers or lenders can also purchase buydowns, which are reflected in the closing costs as "seller credits" or "lender credits".

The long-term savings from buying down an interest rate can be substantial. On a 30-year mortgage with a 7 percent interest rate, clients pay just over $279,000 on interest alone, but with a 6.75 percent rate, they'll pay just over $266,000.

To qualify for a buydown, you'll need to be purchasing or refinancing a primary residence or second home, not an investment property or cash-out refinance.

Buying points can sometimes represent a significant upfront cost and come with risks, but they can also make owning a home much more affordable in the long term.

Nearly 2 out of 3 borrowers taking out purchase loans paid points to lower their rate in 2022 and 2023, according to studies by the Consumer Financial Protection Bureau and Freddie Mac.

Not every client will benefit from buying points, but homesellers and homebuilders may offer to buy down the homebuyer's interest rate, often in the form of temporary rate buydowns that only last one to three years.

Here are some key points to consider when weighing the pros and cons of buying points:

Buying points can be a great way to lower your monthly mortgage payments, but it's not without its downsides.

A potential con of buying points is that it may lull the borrower into buying a more expensive home than they can afford.

The lower monthly costs of buying points are temporary, so homebuyers must be prepared for a jump in payments.

This can be a significant increase, and borrowers need to have a plan in place to cover it.

Borrowers who assume that their income will rise enough to afford future payments could find themselves in financial trouble if this fails to occur.

It's essential to carefully consider your financial situation and long-term goals before deciding to buy points.

Temporary vs. permanent buydowns are two options to consider when thinking about your mortgage. This choice depends on your budget, what the lender or seller is offering, the market, and other factors.

Temporary buydowns are more common nowadays, offering a short reprieve from high interest rates. This type of buydown typically lasts for a few years, after which interest returns to the original rate.

A 2-1 buydown is a popular temporary option, lowering interest by two points during the first year and one point during the second year. This means you can have a lower payment for two years.

However, it's essential to be prepared for a jump in payments after the temporary buydown period ends. Borrowers who assume their income will rise enough to afford future payments could find themselves in financial trouble if this fails to occur.

Here are some key differences between temporary and permanent buydowns:

In recent years, temporary buydowns have become more common, offering a short-term solution to high interest rates. This can be a good option for homebuyers who want to lower their payments for a few years.

Buying down your interest rate can be a great way to save money in the long run, but it's essential to understand the tradeoffs involved. A mortgage buydown involves paying more money upfront in exchange for a lower interest rate, which can lower your monthly payments.

The more points you buy, the lower your rate goes, but lenders may put a cap on how many points you can purchase. For example, on a $200,000 loan at an original 7 percent rate, four points would cost $8,000 and reduce your interest payments by over $92,000 over 30 years.

Not every client will benefit from buying points, and it's crucial to consider your specific situation before making a decision. If you're unsure, a financial advisor can offer more concrete advice based on your circumstances.

A 3-2-1 buydown mortgage means that you have a fixed "step down" during the first three years: 3%, then 2%, then 1%. This can be a great option for buyers who want to take advantage of lower interest rates, but it's essential to understand that the lower monthly costs are temporary.

Here are some key things to consider when deciding whether to buy down your interest rate:

A 3-2-1 buydown mortgage allows a homebuyer to obtain a lower interest rate for at least the first few years of the loan, or possibly its entire life. The interest rate is reduced by 3% for the first year, 2% for the second year, and 1% for the third year.

The cost of the 3-2-1 buydown is typically covered by the seller or homebuilder, equating to the savings to the buyer in the first three years. This cost is not absorbed by the buyer.

The original interest rate then kicks in for the remaining term of the loan. This is in contrast to a 2-1 buydown, where the rate is reduced by 2% for the first year, 1% for the second year, and then rises to the original rate when the buydown period ends.

Buying down interest rates can have a significant impact on your mortgage payments and overall cost of homeownership. Consider this: on a $200,000 mortgage, the difference between a 7 percent and a 6.75 percent mortgage payment is about $33 monthly.

Paying points upfront can save you a substantial amount of money over the life of the loan. On a 30-year mortgage with a 7 percent interest rate, clients pay just over $279,000 on interest alone. With a 6.75 percent rate, they’ll pay just over $266,000, a net of $11,000 in savings over the life of a loan from just $2,000 upfront.

The benefits of buying down interest rates are numerous. Lower monthly payments mean more cash flow and less of a monthly burden, making payments more manageable. This also frees up income for improvements and maintenance, essential if the property is an investment to flip.

Here are some specific examples of the long-term interest savings you can expect:

Buying down interest rates can also make owning a home more affordable in the long term, especially if you plan to be in your home for a long time. In fact, on a $200,000 loan at an original 7 percent rate, four points would cost $8,000, but would reduce the interest rate by 2 percent, saving you over $92,000 less on interest over 30 years.

Lenders may offer buydown promos to tempt buyers away from other companies if rates are high. This can be a great opportunity for buyers to negotiate a better deal.

In a buyer's market, sellers are more likely to pay for buydowns to remain competitive. This can be a win-win situation for both the buyer and the seller.

Sellers may prefer to offer a buydown than lower the price of the home, as the math usually works out better in the long run. This is especially true in a buyer's market.

Typically, the cost of a 3-2-1 buydown mortgage is covered by someone other than the buyer, such as the seller, homebuilder, or lender. This can be a huge cost savings for the buyer.

Motivated sellers may finance a mortgage buydown to entice buyers with lower mortgage rates. This can be a great way for sellers to attract buyers and close the deal.

Homebuilders may also offer buydowns as incentives to potential buyers of newly built homes. This can be a great way for buyers to get into a new home at a lower cost.

In some circumstances, a company relocating an employee to a new city may cover the buydown cost to ease the expense of relocation. This can be a huge help for employees who are moving to a new area.

Calculating the breakeven point is crucial before opting for a buydown. This involves doing some math to determine the point at which you'll break even on the costs of the buydown.

To calculate the breakeven point, you'll need to divide the total cost of the points by the monthly savings you'd get from it. This will tell you how many months it will take to break even.

With a 3-2-1 buydown mortgage, the borrower pays a lower than normal interest rate over the first three years of the loan. This means you'll have lower monthly mortgage payments during this period.

The loan interest rate is reduced by 3% in the first year, 2% in the second year, and 1% in the third year. For example, a 5% mortgage would be just 2% in year one.

After the buydown period ends, the lender charges the full interest rate for the remainder of the mortgage term. This means you'll have bigger payments later on.

You may be able to deduct the cost of mortgage points, which can be a significant advantage. However, this can also increase your closing costs.

Here's a rough estimate of the pros and cons of mortgage buydowns:

Think of this as a cost analysis of mortgage rate buydowns. To make a decision, you'll need a good idea of how long you plan to be in the home. If you think you'll still be there to reach the breakeven point, then the buydown is probably a good idea.