We already know how important interest rates are when we are buying or refinancing a property. Especially when your loan amount is in six figures, even a 0.5% difference in interest rate can make a huge difference in your monthly installments.
Have you noticed what happens when mortgage rates rise in the market abruptly? Do the private lenders immediately start offering Mortgage financing strategies also referred to as mortgage rate buydown?
Here in this guide, we’ll discuss everything from how buydown works, different types of buydowns, and the pros and cons of buydown mortgage rates.
Let’s get started to know whether or not you should invest in buying down the mortgage rates?
What is Buydown?
Buydown is a technique that allows the borrowers to get a low mortgage interest by paying some extra expense at closing. This extra money is also referred to as discount points, prepaid interest points, or mortgage points. Its one-time fees are paid upfront to enjoy the lower interest rate for the entire loan duration.
The buydown mortgage interest can be temporary or permanent!
Before you agree with loan terms, it’s important to understand the difference between both buydown interests. So, you can make an informed decision that whether or not mortgage rate buydown is worth investing in.
How does a buydown mortgage work?
The loan terms & conditions, and extra money that you pay upfront can be negotiated depending on the lender. What matters the most is whether you are opting for a temporary or permanent mortgage buydown rate? As loan terms are different for both the loan plans. So, let’s see how it works!
Temporary mortgage rate buydown:
When you prefer a temporary mortgage buydown, keep in mind that the interest rate is lower in the introductory period but increases abruptly over time.
- The mortgage interest rate is set lower for the initial phase. The Lender will introduce many buydown plans with an interest rate of up to 3% or below your current mortgage rates.
- Based on the buydown plan, the interest rate is bound to increase every year which is typically 1% higher for the rest of the loan plan. For example, In a 2-1 buydown plan, the interest rate will be 3% for the first year which will eventually rise to 4% in the second year.
- The mortgage rate remains fixed for the rest of your buydown plan. As we discussed earlier, after the mortgage interest has been increased to 4 % in the second year, the lender can’t raise it for the remaining loan term.
- All the additional expenses for the buydown mortgage rate are paid off during the closing period.
Permanent mortgage rate buydown:
As the name reveals, a permanent buydown mortgage rate means the interest remains fixed for the entire loan term. Once fixed by the lender, it can’t be increased or decreased.
- If you want to reduce your mortgage rate, you have to pay a high additional fee during closing. The more you pay upfront, the more the mortgage rate will be reduced. As the lender uses your discount points to offer a lower buydown mortgage rate.
- The mortgage rate remains fixed for the whole loan plan unless and until you don’t opt for an adjustable-rate mortgage (ARM)in the future.
- As suggested by the lender, you’ll have to pay the buydown mortgage rate expenses at the time of loan closing.
How to pay for a mortgage buydown?
Generally, there are three popular and most common ways to pay for a buydown mortgage rate:
- Pay by yourself/ Cash
- Ask the Lender to pay for Buydown.
- Or, Finance your loan plan.
Now, let’s see how each of these methods works!
Pay by cash
If possible, it is the best way to pay for mortgage rate buydown. Calculate your bank savings, or try to reduce your monthly expenditures so you can easily afford to get the lower rate of interest. Keep in mind that the money you spent for the buydown mortgage rate is a one-time fee paid upfront.
Ask the Lender
Many lenders offer a buydown rate mortgage as an incentive when you sign a contract with them. So, you can shop around and look for such private lenders to get the best mortgage buydown rate for free.
A Closing cost incentive is another advantage that you can use to pay the buydown mortgage rate. You can negotiate with the builder by using their “in-house” mortgage company.
Another option is to use the gift funds received by your friends, family, and colleagues to cover the buydown mortgage rate cost.
Different types of Mortgage Buydowns:
Most private lenders offer two standard types of temporary mortgage buydown options with their own loan terms & conditions. Read below to understand each type and find out the difference:
When you choose this buydown option; it means you agree with the interest rate which is 3% below your current mortgage rate. Each number signifies the difference in the buydown interest rate and prevailing mortgage rates.
This loan plan is beneficial for buyers who are planning to live in the house for a longer duration.
The Break Even Point:
Make sure to calculate the break-even point to determine whether or not the buydown mortgage rate is worth it!
The Break-even point is equally important as the buydown mortgage interest is! It indicates how long it takes to recoup the refinance closing costs.
|Breakeven Point = Total Cost Of Points ∕ Your Monthly Savings|
Follow the steps below to calculate the Break-even point:
- Get the LOAN ESTIMATE from the lender and add up the additional loan cost.
- Add separately the fees for extra ‘Services You Can Shop.’
- Now, Calculate Your Monthly Installment Savings.
- Finally, Divide Your Total Loan Cost By Your Monthly Savings
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 plan to only live in your home for a short time period.
Benefits and drawbacks of buying down your interest rate
|Buydown mortgage rate help reduce your monthly installments.||The total closing costs become higher due to additional expenses.|
|Mortgage rate interest is lowered for the entire duration of your loan.||Temporary mortgage buydown can increase your monthly payment and interest rate.|
|You can add up the buydown mortgage costs in your tax history||Unfortunately, if you couldn’t pay your EMIs, you may end up losing your house.|
|Due to the low-interest rate, you become eligible for getting high loan amounts||The High buydown mortgage expense may deplete your cash savings.|
Are there any limitations on Buydowns?
There are some restrictions that you need to know when opting for buydown mortgage rates. It’s better to consult 3-4 lenders and shop around for the best deals.
- Buydowns mortgages are applicable only when you are refinancing or buying the first or second home.
- In order to buy down a home loan, the borrowers have to qualify for the zero-point loan.
- Government-backed refinance loans are eligible for buydowns.
- Cash-out refinances and Real estate transactions on investment properties are not eligible for buydowns.
FAQs about Buydown Mortgage:
What is a mortgage rate buydown?
A Buydown mortgage is the financial strategy or technique offered by private lenders to lower your prevailing interest rate by refinancing the loan terms. The Buydown mortgage rate can be temporary or permanent depending on your preferences.
Can I reduce my interest rate without refinancing?
Although it’s quite difficult to reduce the interest rates without refinancing. But still, there is an option. You can request the lender to alter the locked-in loan terms due to financial hardships. Most of the lenders extend your loan terms.
What are the best ways to have lower interest rates?
- Increase the size of your Down Payment.
- Maintain a good record of the transaction history.
- Pay full and on-time monthly installments.
- Improve Your Credit Score.
- Buy Mortgage Points.
- Keep your loan terms Short.
- Keep an eye on the housing market
- Lock the mortgage rate before the market rates Increase.
How Much Does It Cost To reduce An Interest Rate?
Mortgage lenders exchange discount points to reduce the mortgage rate. For example, the lender may charge 1 discount point in the exchange for lowering the mortgage rate by 0.30%.
Whereas 1 discount point is usually 1% of your loan amount. That’s why it is recommended to buy more discount points at the time of loan closing.
Who can Buydown a mortgage?
Most of the time it’s the buyers who enjoy the benefits of buying down the mortgage. But Sellers and builders are also eligible for buydown mortgage rates.
Some lenders offer buydown mortgage rates as an incentive to buyers. They use their escrow accounts to pay for the discount points under the seller concession.
Are Buydowns worth it?
As per our experience and knowledge, buydowns are totally worth it as they can save some cash in monthly payments by reducing the interest rates. Even a 1% down in interest rate can save a significant amount, especially when you have borrowed six-digit money.
To enjoy more benefits, buy more discount points at the time of closing. Trust us, it will help you save money in the long run.
Make sure you have enough savings even after paying the down payment and closing costs.
Remember buying down a mortgage makes sense only to those who are confident their income will increase in the future.