
- Mortgage rate buydowns allow borrowers to secure a lower interest rate to lower their monthly payment, either temporarily or permanently, by paying upfront fees.
- When receiving a temporary buydown, it is important to make sure you are financially prepared to pay the mortgage payments at the full interest rate following the buydown period.
- You may reduce the interest rate without a buydown through strategies like increasing your credit score, making a higher down payment, and choosing an adjustable-rate mortgage.
With mortgage interest rates strongly affecting mortgage payments, many homebuyers look for ways to reduce their interest rate. One way to reduce your rate, either temporarily or permanently, is to buy down the interest rate.
In this article, we’ll explain how to buy down mortgage rates, the pros and cons of doing so, and some alternatives for those who want a lower rate without a buydown.
Understanding How To Buy Down a Mortgage Rate
A mortgage rate buydown is an arrangement where upfront fees are used to lower the interest rate on a mortgage for a specified period.
In many cases, the rate is reduced for the first few years of the loan, lowering the monthly payments in the early years and making homeownership more affordable in the short term.[1] However, there are also permanent buydowns to reduce the rate for the life of the loan.[2]
How Does a Mortgage Buydown Work?
Temporary mortgage rate buydowns are commonly used as buyer incentives by third parties such as homebuilders, sellers, and even mortgage lenders.[3]
The third party pays an upfront fee equal to the total savings the buyer receives from the lower interest rate. Paying this fee will reduce the interest rate and correspondingly lower mortgage payments for the buyer, usually for the first few years of the loan.
When the buydown period ends, the interest rate will adjust to the higher rate agreed upon in the original home loan contract. As a result, the homeowner will be responsible for paying higher monthly mortgage payments moving forward.[1]
Permanent mortgage buydowns can be initiated by a third party, but they are often initiated by the borrower.[4] This type of buydown uses mortgage points (also called discount points) to permanently lower the interest rate without paying the full cost of the saved interest. For example, a borrower might purchase a mortgage point for 1% of the loan amount in exchange for reducing the interest rate by .25% for the life of the loan.
What Is the Financial Impact of Buying Down a Mortgage?
A temporary buydown produces the following financial effects:
- The party covering the buydown fees issues an upfront payment to the lender in the total amount of interest the borrower saves through the arrangement. If the lender is offering a buydown, they absorb the cost.
- The borrower benefits from a lower monthly mortgage payment during the buydown period.
- The borrower benefits from paying less in total interest expense.
- The borrower must be financially prepared to cover the higher mortgage payment at the full interest rate when the buydown expires.
A permanent buydown produces the following financial effects:
- The borrower (or a third party) pays upfront to purchase one or more mortgage points at the rate of 1% of the loan amount per point.[4]
- The borrower benefits from lower monthly mortgage payments until the loan is refinanced or paid off.
- The borrower benefits from paying less in total interest expense over the life of the loan.
Who Can Buy Down a Mortgage?
Anyone can buy down a mortgage as long as:[1]
- The borrower qualifies for the mortgage loan at the full interest rate.
- The property type and use allow for a buydown. Investment properties are ineligible for temporary buydowns.
- The loan type provides for a buydown. Cash-out refinances are ineligible for temporary buydowns, and adjustable-rate mortgages (ARMs) have some restrictions.
- The buydown doesn’t exceed the limits. The rate reduction for a temporary buydown cannot exceed 3% or require a rate increase of more than 1% per year for the borrower. There is no official limit for buying points to permanently reduce the rate, but most lenders don’t allow borrowers to buy more than three points.[5]
There may be state-specific restrictions or limitations on government-backed products like FHA loans.
Common Mortgage Rate Buydown Structures
There are multiple ways to structure a buydown.
1-0 Buydown
The interest rate is reduced by 1% for the first year, then returns to the full rate.
2-1 Buydown
The interest rate is reduced by 2% for the first year, 1% for the second year, then returns to the full rate.
3-2-1 Buydown
The interest rate is reduced by 3% for the first year, 2% for the second year, 1% for the third year, then returns to the full rate.
Permanent Buydown
The interest rate is permanently reduced. The amount of the reduction depends on how many points the borrower purchases and how much each point reduces the rate. Typically, each point purchased reduces the interest rate by .25% at a cost of 1% of the purchase price for each point purchased.[5]
Pros and Cons of Buying Down a Mortgage Rate
Consider the following advantages and disadvantages of mortgage buydown:
Benefits of a Mortgage Buydown
- The borrower’s mortgage payment is reduced for the buydown period.
- The reduced payment during the buydown period can free up cash to be used for home improvements or other homeownership expenses.
- If a third party pays the buydown fee, the borrower saves on interest expense.
- If points are used to permanently reduce the rate, the borrower could save on overall interest expense, even if they pay for the points themself.
Potential Drawbacks and Tradeoffs of a Mortgage Buydown
- Buydowns require an upfront fee.
- The increase in the monthly payment amount once a temporary buydown expires could cause financial stress for the borrower if they are not prepared.
- A home builder or seller may offer a temporary buydown in exchange for a higher purchase price, which could cost the buyer more in the long term.
Alternatives To Buying Down a Mortgage Rate
If you are looking for a lower interest rate, but a buydown is not the right solution, here are a few alternatives:
- Consider an adjustable-rate mortgage. ARMs typically offer lower starting rates than fixed-rate mortgages. However, there is a risk that mortgage rates could increase, which would increase your mortgage payment and total interest expense.[6]
- Increase the down payment. Higher down payments often warrant lower rates.[7] You may earn a favorable rate by making a 20% down payment.
- Choose a shorter loan term. A 15 or 20-year mortgage may offer a lower rate than a 30-year mortgage.[7] However, the monthly payments will be higher because the loan amount is spread over fewer payments.
- Improve your credit score. Lenders usually offer lower interest rates to borrowers with higher credit scores.[7]
- Refinance if rates drop in the future. Refinancing allows homeowners to replace their existing mortgage with a new mortgage under new terms. If mortgage rates go down in the future, you may be able to refinance to secure that lower rate. However, refinancing comes with fees, so you should use a mortgage refinance calculator to decide if a refinance makes financial sense.
The Bottom Line
Buying down mortgage rates may reduce monthly payments and total interest expense. However, the upfront cost and increased mortgage payment amounts following a temporary buydown prevent this from being a solution for all homebuyers.
Explore all mortgage options and current rates to make an informed decision in choosing the most suitable fit for you.