Mortgage rates have been a hot topic for the last few months and one method to drive them downward is: a Buydown.

Disclaimer: I am not a mortgage broker. Seek lending advice from a licensed mortgage loan officer. This is not financial advice and I recommend you do your own due diligence.

This is written from the lens of both an agent and as a buyer.

From my years in the industry, I’ve seen a lot of different pre-approvals, pre-qualified letters, have witnessed different methods of creative financing and have personally closed on a property using a similar technique.

So first let’s start with what’s a Buydown?

Let’s take a look at a simple definition from Investopedia which states:

A buydown is a mortgage financing technique with which the buyer attempts to obtain a lower interest rate for at least the first few years of the mortgage or possibly its entire life.

Investopedia’s Buydown definition

To be clear these are one-time fees paid upfront. And the beauty is it doesn’t necessarily have to be paid for by the buyer! With today’s increasing rates, some Sellers or builders in this market are willing to pay for these buydowns for a qualified Buyer to purchase their home (in the time of this writing it’s currently sitting at 6.27% for a 30 year fixed conventional).

With this buydown method, depending on the structure of the loan, it can temporarily reduce a buyer’s monthly mortgage payment and/or reduce the interest rate for a given amount of time at the beginning of the loan. In most instances, buyers must first qualify for the standard interest rate at the zero-point loan to be able to qualify for a buydown.

And there are different buydown structures. This is not meant to be an exhaustive list but these are some options:

• 2-1 buydown
• 1-0 buydown
• 3-2-1 buydown
  

Buydowns rate reductions are based on a standard contract rate (whatever a qualified Buyer would normally get approved for depending on the type of loan, downpayment amount, etc,.)

So let’s take the 2-1 buydown example. This structure allows to temporarily reduce a Buyer’s interest rate for only the first two years of the loan. The first number indicates the rate reduction on the first year. The second number indicates the rate reduction on the second year, and then the third year when the buydown expires reverts to the current standard rate.

Here’s what that would look like in an imaginary scenario where a Buyer is approved for 5.5% for a $400,000 loan using a 2-1 buydown:

Year 1 = 3.5%
Year 2 = 4.5%
Year 3 = standard contract rate

Because every Buyer’s finances and situations are very different I don’t recommend this method for everyone. Although the idea of a reduction in interest rates and a large reduction in monthly mortgage payments sounds appealing (especially in today’s volatile market), we have to remember that this method requires $$$ upfront (cha-ching.)

How much does a buydown cost?

Like I said this method requires fees. So similar to discount points the cost for each point to reduce the interest rate depends entirely on the overall loan amount of the borrower. Each point is typically equivalent to 1% of the loan amount.

Simple example below:

Loan obtained by borrow: $500,000
1 discount point= $5,000

Different mortgage lenders offer different structures. Some lenders may offer a borrower the ability to reduce their interest rate by .25% in exchange for a point.

So in the above example, if the borrower is obtaining a mortgage for $500,000 and is offered an interest rate of 5.5%, paying $5,000 would lower their interest rate to 5.25%.

When a buydown isn’t beneficial

Like I said this method is a fantastic and creative option for today’s market-of-the-moment however it requires a bit of planning. This wouldn’t work for a buyer who doesn’t plan on staying in the home for very long. This also wouldn’t work for a buyer who doesn’t have enough in savings. Obviously the ideal situation is having the Seller pay for these costs, but we all know it just doesn’t work out like that sometimes. Having enough cash in hand between closing costs, origination points, after closing repairs, etc., plus this buydown method requires having enough “cushion” without going house broke.

Because the rate reductions are temporary, they would be beneficial to someone that maybe anticipates a greater salary before the rate reduction expires, or someone like a stay-at-home parent planning on going back to work. (Financially planning ahead is key here.) I also would rather put a greater down payment in versus the buydown option (just my two cents).

In addition, buydowns can also be restricted. Again, please speak to a qualified lender. They’re typically only offered to primary and secondary residences and do not qualify for investment properties. Government backed loans such as FHA loans are also restricted using the buydown method (it’s only permitted on fixed-rate loans).

Financing is such a great topic to speak about. And, because of it’s complexity I do plan on writing more about this! (I promise!) It is after all, the core of any real estate transaction; without it, deals fall through.

This was more of the spark notes version of this complicated method. More to come as I do want to talk about the break-even-point and how to calculate that (hint: it’s not hard). But more on that later!

Send me a message if you have any questions! You can reach me in all the places.