What is a BUYDOWN and How Does It Help Buyers and Sellers?

Posted by John Peña on Friday, January 27, 2023 at 11:31:20 AM By John Peña / January 27, 2023 Comment

With interest rates hovering around 7%, both buyers and sellers find themselves in an interesting situation. For the home buyer, higher interest rates mean higher mortgage payments and decreased purchasing power. For the home seller, there are fewer buyers in the market, and those buyers are much more selective and price-conscious. However, there is a financing technique called a mortgage buydown that can help.

What is a Buydown on a mortgage?

A buydown is a way for a borrower to obtain a lower interest rate by paying discount points at closing. Discount points also referred to as mortgage points or prepaid interest points, are a one-time fee paid upfront. In the case of discount points, the interest rate is lower for the loan term.

In an alternate form of a buydown, the points purchased reduce the interest rate for a given amount of time at the beginning of the loan. This arrangement is typically paid for through funds escrowed by the seller. Since the interest rate is lower during this time, the borrower's monthly mortgage payments are more affordable.

Because mortgage rates are forecasted to continue rising in 2022, the buydown method can be a useful tactic to protect yourself against rate hikes. Once you discover which loan option is right for you, look at today's rates and compare them to what typical rates look like right now to determine if the buydown method could help you save.

How much does it cost to buy down an interest rate?

The cost for each discount point depends entirely on the amount you, as the borrower, take out on the loan. Each point that a borrower pays is equivalent to 1% of the loan amount.

For example, a mortgage lender may offer a borrower the ability to reduce their interest rate by 0.25% in exchange for a point. So, if the borrower obtains a mortgage for $400,000 and is offered an interest rate of 4%, paying $4,000 would lower their interest rate to 3.75%.

Who can buy down a mortgage?

Although the buyer benefits from a buydown, the buyer isn't always the one who buys down a mortgage. Sellers and builders can also be responsible for purchasing points to lower the buyer's interest rate.

Buyers

The majority of buydowns are negotiated between buyers and lenders. Home buyers offer to pay a specific number of points upfront, and in return, they receive a lower interest rate, making their mortgage more affordable for a certain number of years or over the loan term, depending on the buydown structure.

Sellers

Sellers may also offer to buy down a buyer's mortgage to incentivize the buyer to purchase their home. In these circumstances, the seller will make the one-time payment and deposit it into an escrow account or pay for points over the entire loan term as part of seller concessions.

This payment, or subsidy, provides the lender with the funds necessary to lower the buyer's interest rate so that the buyer can more easily afford their home loan.

Builders

Like sellers, builders may also offer to pay points to buy down buyers' mortgages. Typically, a builder will make these upfront payments to entice early buyers to purchase properties in their newly built communities. Once their communities are established, builders are usually less inclined to offer this kind of incentive. However, in this market, we do see plenty of builders offering to buy down points.

Bottom Line

Generally speaking, mortgage buydowns enable buyers to lower their monthly mortgage payments either permanently or in the first few years of their loan. By paying discount points at closing, buyers can reduce their interest rates slightly, leading to long-term savings. However, buydowns are not appropriate for all buyers.

If you're interested in buying down your mortgage, you should calculate your breakeven point to ensure the amount of time it takes to recover the money spent on points is worth the upfront investment.

Of course, you can always reach out to us for more information in deciding whether or not this is a good option for you!