How a Mortgage Buy Down Can Help with Rising Interest Rates

A mortgage buydown is one potential option to reduce your interest rate, especially when interest rates are on the rise while you’re trying to buy a home. When you are looking to buy a house, it is a serious financial commitment, and you want to make sure you can handle the long-term effects of the purchase price along with the monthly mortgage payments. While you might think that the only time to buy a house is when interest rates are low, there are other ways to manage the housing market when dealing with rising interest rates.

 One such option is to talk with your mortgage broker about a mortgage buydown to help ensure your mortgage payments will be manageable for you now and into the future. By committing to paying more upfront, you can end up securing a lower interest rate on your mortgage and help you save money in the long term. Here’s what you need to know about how a mortgage buydown can help with rising interest rates.

What Is a Mortgage Buydown?

A mortgage buydown is a way to obtain a lower interest rate as a borrower. The borrower would agree to pay mortgage points at closing. Mortgage points, also known as discount points, are a one-time fee paid at closing that takes a percentage point off your mortgage interest rate offered. As mortgage rates continue to rise, a mortgage buydown can be a useful tactic for buyers to consider in an effort to protect against rate hikes. The mortgage buydown method depends on the amount taken out on the loan. Each mortgage point is equivalent to 1% of the loan amount. For example, a borrower may be able to reduce their mortgage interest rate by .25% in exchange for one mortgage or discount point.

How Do Mortgage Buydowns Work?

A mortgage buydown is negotiated between the borrower and mortgage holder with a variety of potential structures and arrangements. The most common structures are the 1-0 buydown and 2-1 buydown. Certain mortgage buydown structures expire, so it is important that you understand all the ins and outs of your mortgage buydown from the start. Here are a few examples of mortgage buydown structures and how they work.

3-2-1 Buydown

A 3-2-1 buydown refers to a mortgage buydown where the borrower pays less interest on their mortgage in the first 3 years. All mortgage points paid upfront at closing will reduce the interest rate on the mortgage for each of the first 3 years, typically by 1%. In one such scenario with a 3-2-1 buydown, a homebuyer may work out a mortgage buydown where they pay 2% interest in year 1, 3% interest in year 2, and 4% interest in year 3, before moving into the full interest rate of 5% in year 4 and going forward. The number of mortgage points for the buydown may differ depending on the lender, but the goal is for the cost of the buydown to equate to what the buyer would end up saving on interest during the first 3 years.

2-1 Buydown

A 2-1 buydown refers to a common type of mortgage buydown where the buyer pays a discounted interest rate for the first 2 years of the loan term. In a 2-1 buydown situation, the borrower would end up with a 2% lower interest rate during year 1, followed by a 1% lower interest rate during year 2. Afterward, the buyer would be expected to start at the standard interest rate in year 3 through the duration of the loan. A 2-1 mortgage buydown can help a homebuyer save thousands of dollars in interest by covering some of those costs upfront.

Permanent Mortgage Rate Buydown

In some cases, a buyer may be able to work with their lender to establish a permanent mortgage rate buydown. If a buyer purchases enough mortgage points to reduce their interest rate for the duration of the loan, the buyer would pay a larger sum upfront, but this would prevent their monthly mortgage payments from ever increasing. A loan without any mortgage points applied is known as a zero-point loan. To negotiate a permanent mortgage rate buydown, the borrower would want to determine how long they plan to stay in the home and whether this will positively impact monthly and yearly savings.

Should You Buy Down Your Mortgage Rate?

A mortgage buydown may be a beneficial option for you when the mortgage points do not significantly increase the amount of money down or increase the purchase price of the home. A buyer may also work with a seller or builder who offers to pay part of the discount on behalf of the buyer. No matter who purchases the mortgage points, there are many benefits and a few drawbacks for buyers, sellers, and builders when considering whether to buy down a mortgage rate. Benefits for buyers include a lower interest rate for part or all of the mortgage duration. Benefits for sellers include incentives for buyers to consider purchasing their home. The seller may offer to make a one-time payment into an escrow account as part of seller concessions. This would provide the lender with the funds necessary to lower the potential buyer’s interest rate so they can more readily afford a home loan while interest rates are high.

What Are the Restrictions for Buydowns?

There are some limits and restrictions on the option for a mortgage buydown. Restrictions for buydowns typically impact buyers looking to purchase or refinance an investment property instead of a primary residence or second home. The type of mortgage rate will also impact the opportunity for a mortgage buydown. Some states also have specific regulations and restrictions on how the mortgage buydown process can work and how many points can be purchased on behalf of a buyer. Other limits on buydowns include federally funded programs like FHA loans because mortgage buydowns are only permitted when a buyer selects a fixed-rate mortgage for purchasing a home.

Final Thoughts: Mortgage Buydowns Are Worth It

The bottom line is that a mortgage buydown might be worth it for buyers looking to purchase a home when interest rates are on the rise, especially when the seller or builder offers to pay some or all of the mortgage points. A mortgage buydown can help reduce your monthly mortgage payments for a few years or for the duration of the loan. Check out our handy mortgage calculator with Florida Realty Marketplace when estimating the cost of buying a home in Florida. Our team of real estate agents will also talk you through all your options and make sure you find the best solutions available for purchasing a home.