Finding ways to lower your monthly mortgage payments is likely one of your top priorities when buying a home. You may have already considered strategies like making a larger down payment or improving your credit score to secure a lower interest rate. But there’s another option you might not be aware of: the buydown. This lets you lower your mortgage interest rate by paying for it upfront.
This guide explores how a mortgage buydown works, the different buydown options, and whether it makes financial sense for your situation.
What Is a Mortgage Buydown?
A mortgage buydown is a financial arrangement in which you pay a fee to reduce your mortgage’s interest rate, resulting in lower monthly payments. This fee is paid at closing, and each point purchased reduces the interest rate by a specific amount. Typically, each point costs 1% of the total loan amount.
For example, if you’re borrowing $300,000, purchasing one point would cost you $3,000. The exact reduction in interest rate varies by lender, but most often, one point lowers the rate by 0.25%.
Let’s look at how this works in practice.
Example of Buying Down Points
Imagine Sally is purchasing a home for $500,000 with a $100,000 down payment. She plans to borrow $400,000, and her lender offers a 30-year fixed mortgage with a 3.75% interest rate. Sally wants to lower her interest rate to reduce her long-term costs, especially during the first few years of paying off the mortgage, as the interest is front-loaded.
Her lender informs her that she can purchase one point for $4,000 (1% of her $400,000 loan), reducing her interest rate by 0.25%. By paying this amount, Sally’s interest rate would drop to 3.5%, leading to long-term savings on her monthly payments.
Who Pays for the Buydown?
In most cases, buyers are responsible for paying for the buydown to reduce their mortgage interest rate. However, there are instances when the seller or builder may cover this cost as part of the deal. This is more common in a buyer’s market, where sellers must make additional concessions to attract buyers. For new homes, builders may offer to buy points as an incentive to encourage sales.
Types of Buydowns
Homebuyers can use different types of buydown strategies to reduce their interest rates. Each method offers unique benefits depending on your financial goals and the length of time you plan to stay in the home.
1. Interest Rate Buydown
An interest rate buydown is when the reduced interest rate applies to the entire duration of the loan. This approach tends to have higher upfront costs but can result in significant long-term savings, especially if you plan to stay home for an extended period. The upfront fee is usually paid in full at closing, and the lower rate remains fixed throughout the life of the mortgage.
2. 3-2-1 Buydown
A 3-2-1 buydown is a strategy that reduces the interest rate for the first three years of the loan. After the third year, the interest rate returns to the original amount.
Here’s how it works:
Year | Interest Rate Reduction |
Year 1 | 0.75% lower than the original rate |
Year 2 | 0.50% lower than the original rate |
Year 3 | 0.25% lower than the original rate |
Year 4 and beyond | Returns to the original rate |
This type of buydown is appealing if you’re looking for reduced payments during the early years of homeownership. A similar strategy is the 2-1 buydown, which reduces the interest rate for the first two years instead of three.
Is It Worth Buying Down Points?
Before deciding whether to buy down points, evaluating your financial situation and how long you plan to stay in the home is essential. To help determine if buying points is the right move for you, consider the following factors:
1. Breakeven Point
The breakeven point is the time it will take to recoup the upfront costs of buying points through the monthly savings. You can calculate this by dividing the total cost of the points by the amount you’ll save on your monthly mortgage payments.
For example, if purchasing points cost you $3,000 and save you $50 a month, your breakeven point would be 60 months (or five years). Buying down points could save you money if you plan to stay in the home for longer than five years. However, if you plan to sell before reaching the breakeven point, the upfront cost may not be worth it.
2. Prioritizing the Down Payment
If you’re deciding between putting more money toward your down payment or buying points, it’s generally better to prioritize the down payment. A larger down payment reduces the overall loan amount, which leads to lower monthly payments and possibly avoids private mortgage insurance (PMI).
3. Long-Term Savings
If you plan to stay in your home for a long time, purchasing points to lower your interest rate could offer significant savings over the life of the loan. The more time you spend at home, the more beneficial the lower interest rate becomes. However, investing in points upfront may not make sense if you expect to move within a few years.
Situations Where Buying Points May Not Be an Option
While buying down points can be an attractive strategy, it’s not always available for every mortgage situation. For example, some lenders may not allow you to buy down points for an investment property or during a cash-out refinance. Discuss your options with your lender to see if buying points are feasible for your loan type.
Conclusion
A mortgage buydown can help lower your interest rate and reduce your monthly payments, but comparing the upfront cost with the long-term savings is essential. Whether you choose to lower your interest rate for the entire loan or go with a temporary plan like a 3-2-1 buydown, knowing how long it will take to recover the costs and how long you plan to stay in the home is crucial. Talk to your lender about whether buying down points is the right strategy for your mortgage and financial goals. With careful consideration, you can make a decision that helps you save both now and in the future.
FAQs
Is interest rate buy down worth it?
An interest rate buy-down can be worth it if you plan to stay in the home long enough to recoup the upfront cost through lower monthly payments.
How can I get my interest rate lowered on my mortgage?
You can lower your interest rate by refinancing, negotiating with your lender, or, if eligible, opting for a mortgage modification.
Can I change my mortgage to a lower interest rate?
Yes, you can refinance your mortgage for a lower interest rate, depending on your credit score, home equity, and market rates.
Does paying down mortgage reduce interest?
Paying down your mortgage principal reduces the total amount on which interest is calculated, potentially saving you money over time.