Interest Rate Buydowns
Rising interest rates affect home affordability for buyers by increasing the monthly mortgage payment. Buyers can avail of Buy Downs.
What is an interest-rate buy down?
A mortgage buy down is the process of buying discount points at closing to prepay mortgage interest
It’s a tool to help you qualify for a larger loan and purchase a higher-priced house than you could under normal circumstances.
A buy down allows you to pay extra points up front in return for a lower interest rate for the first few years.
The good news: the extra points are tax deductible.
Often, people relocating for employment obtain buydowns because employers often pay the extra points as part of a relocation package.
Buy downs are a financing technique used to reduce the monthly payment for the borrower during the initial years of the loan.
Under some buy down plans, a residential developer, builder or the seller will make subsidy payments (in the form of points) to the lender that "buy down," or lower, the effective interest rate paid by the home buyer.
State agencies often offer lower rate loans. But to qualify, borrowers usually must be a first-time homebuyer and meet income limits based on the median income level of their county.
While the most common way of obtaining a buy down is by paying extra points up front, many mortgage companies now increase the note rate to cover the cost in later years.
How does it work, and are there different types of buy downs?
The most common is the 2-1 buy down, which oftentimes costs 3 additional points above current market points.
It works like this: During the first year of the mortgage, the interest rate is reduced by 2 percent and 1 percent the second year. So if you get a 7 percent interest rate on a 30-year fixed mortgage, you’d pay 5 percent the first year, 6 percent the second year, and 7 percent for the remaining life of the loan.
Another option is the 3-2-1 buy down. This reduces the mortgage rate 3 percent the first year, 2 percent the second and 1 percent the third. Thereafter you pay the full rate.
Some programs are “flex-fixed” buy downs that increase interest at six-month intervals instead of annually.
For example, a flex-fixed jumbo buy down might cost you 1.5 points. The first six months, your rate would be 7.5 percent. The next six months would be 8 percent, the next 8.5, then 9 percent.
The benefit to the buyer is clear: Buyers will pay a lower interest rate either temporarily, or for the life of the loan, potentially saving thousands of dollars. Talking to your bank, lender or mortgage officer will help you get clarity on how a buy down works. Be reminded it is always best to talk to the expert.