With mortgage interest rates climbing, many new homeowners are looking for ways to save money on their monthly mortgage payments. A mortgage buydown can be a great way to combat higher interest rates, making costs less burdensome. Could this option be right for you?
What Is a Mortgage Buydown and How Does it Work?
A mortgage buydown, or temporary buydown, reduces your interest rate and payment for the first one or two years of your fixed-rate mortgage loan, helping make the beginning of your homeownership journey more affordable.
With this subsidy, the seller, buyer, or home builder prepays a portion of the interest rate, allowing for a temporary “discount” on monthly mortgage payments. Typically, you will find that sellers cover the costs of a temporary buydown to incentivize the purchase of their home. However, in recent months, more builders have been offering buydowns to attract buyers to properties.
It is important to note that the lender’s interest rate isn’t ACTUALLY lowered. Your payment reflects a “reduced” rate because the prepayment covers the difference. The seller (or another party paying for the subsidy) deposits a set amount into an escrow account, which temporarily covers the difference in each monthly payment.
Your reduced payment rate + predetermined funds from escrow = the same monthly amount stated in the original loan terms
Mortgage buydowns are short-term, and your interest rate and payment will revert to the full note rate after the designated period expires.
How Is a Mortgage Buydown Different From an Adjustable-Rate Mortgage?
Both temporary buydowns and adjustable-rate mortgages offer reduced interest rates at the beginning of the loan. They are, however, quite different.
An adjustable-rate mortgage provides a lower fixed interest rate for the first 3-10 years of the loan, so they are great for homeowners who don’t plan to stay in their homes forever. After the end of the fixed-rate cycle, the interest rate increases according to the index and margin. These periodical increases are not always predictable, so understanding how ARMs work before securing one is crucial in today’s market.
However, mortgage buydowns are simpler and offer more predictable results. With a mortgage buydown, exact interest rates will be provided to the borrower ahead of time.
Like an adjustable-rate mortgage, a temporary buydown will give you a lower interest rate when it is the most helpful: at the beginning of your loan.
Are There Different Kinds of Mortgage Buydowns?
There are two popular types of mortgage buydowns, and both can benefit new homeowners.
The first kind of temporary buydown is the 2/1 buydown. With a 2/1 buydown, the borrower’s interest rate is reduced by two percent the first year and one percent the second year. After that, the interest rate returns to the original amount specified in the loan terms.
So, if your loan has a regular interest rate of 6.25%, your rate for the first year would be 4.25%. In the second year, the rate would increase to 5.25%. Then, as previously mentioned, for years 3-30, it would revert to 6.25%.
The second kind of mortgage buydown is the 1/0 buydown. This buydown lasts only one year and provides a one-percent reduction in your rate. An example here would be: If your loan has a regular interest rate of 5.75%, your rate for the first year of homeownership would be 4.75%.
Who Can Benefit From a Mortgage Buydown?
There are many Americans who can benefit from a temporary buydown. While this type of subsidy may not be for everyone, the following individuals should consider using a buydown to make homeownership more affordable:
- You expect your income to increase over the next couple of years due to promotions, raises, or other career changes.
- Your spouse plans to return to work in the next 1-2 years, boosting your household income.
- You want a lower interest rate at the beginning of your loan but aren’t ready to commit to an adjustable-rate mortgage.
- You need extra funds for another year or two for life changes but are prepared for the future rate increase.
What Are the Requirements for a Mortgage Buydown?
While sellers and builders usually pay for buydowns, buyers are often eligible to pay for them. However, you will find there are sometimes limits in this situation, so be sure to check with your lender.
Typically, mortgage buydowns can only be used for 1–2-unit homes. Investment properties and other multi-family homes do not usually qualify.
Temporary buydowns can only be combined with certain types of loans. If you use a VA, FHA, or USDA loan, check with your mortgage company to see if you are eligible.
Additionally, there are limits on how much a seller or buyer can contribute to a 2/1 or 1/0 buydown. Usually, the cap is set at around 3% of the home’s purchase price. Be sure to ask your lender about any limits or guidelines as well.
Need More Information About Mortgage Buydowns?
If you think you could benefit from a temporary buydown, we can help you get preapproved now!