Buydowns are most beneficial when a seller or builder offers to pay the discount points on behalf of the buyer without significantly increasing the purchase price of the home. However, if the buyer intends to pay the points themselves, there are certain circ*mstances in which mortgage buydowns are more suitable.
To begin, you must have enough savings that you can afford to pay for a down payment and closing costs and still have a significant amount of cash left over. If that’s the case, having lower payments in the first few years may be beneficial if you expect your income to be considerably higher in the future.
For example, a buydown may make sense for a graduate student who believes their income will double after receiving their degree. Buying down a mortgage would also make sense if a stay-at-home parent were planning to return to work a couple of years after obtaining their loan.
But keep in mind that buydowns are all about paying more money upfront so you can save money in the long run. Therefore, buydowns only really make sense if the buyer in question intends to own the home for an extended period of time.
The Breakeven Point
To determine if a buydown is worthwhile, you must calculate the breakeven point. The breakeven point is the amount of time it’ll take to recoup the cost of the discount points required to lower your interest rate. To do the calculation, you divide the cost of the discount points by the monthly savings.
Breakeven Point = (The Cost Of Points) ∕ (Monthly Savings)
Let’s take a look at a simplified example of how this would work. If you’re looking to obtain a 30-year, $400,000 mortgage with an interest rate of 5%, and your lender charges you four points to reduce your interest rate by 1%, you would first calculate the cost of the points.
Since each point costs 1% of the purchase price, the total cost would be $16,000. By paying 4% in interest instead of the standard 5%, your mortgage payments would drop from $2,147.29 to $1,909.66. Therefore, your monthly savings would be $237.63.
$16,000 divided by $237.63 comes to 67.33, so 67 months is the breakeven point. That means it would take you about 5 years, 7 months to recoup the money you’d have to spend on discount points.
If you, as the buyer, think there’s a chance you’ll sell the home or refinance before the 67-month mark, a buydown wouldn’t make sense for you. Instead, you’d want to think about making extra payments, as you can also save money on interest by paying off your mortgage early.
FAQs
If you are buying a home and have some extra cash to add to your down payment, you can consider buying down the rate. This would lower your payments going forward. This is a particularly good strategy if the seller is willing to pay some closing costs. Often, the process counts points under the seller-paid costs.
How does buying down points lower interest rate? ›
Mortgage points are essentially a form of prepaid interest you can choose to pay up front in exchange for a lower interest rate and monthly payments (a practice known as “buying down” your interest rate). In some cases, a lender will offer you the option to pay points along with your closing costs.
How much does it cost to buy down 1 percent interest rate? ›
This practice is sometimes called “buying down the interest rate.” Each point the borrower buys costs 1 percent of the mortgage amount. One point on a $300,000 mortgage would cost $3,000.
How to buy down an interest rate? ›
Buying Mortgage Discount Points
For example, if you are offered a 6 percent interest rate on a $100,000 loan, you can pay one point ($1,000) to get a 5.75 percent interest rate instead. You can buy down your interest rate by up to 1.0 percent to reduce your interest costs and get a lower payment.
Is it a bad idea to buy a house when interest rates are high? ›
The bottom line
Today's elevated mortgage rate environment isn't preferable for homebuyers, but it doesn't mean that you should refrain from acting, either. If you discover your dream home, can afford the interest rate, find an affordable house, or have an alternative to rent, it can be worth it for you now.
How to get a 3 percent mortgage rate? ›
To qualify, you need to:
- Live in the home yourself as a primary residence.
- A credit score above 580.
- A debt-to-income-ratio below 50%.
- The ability to fund the down payment either in cash or with the support of a second loan at current interest rates.
One mortgage point typically costs 1% of your loan and permanently lower your interest rate by about 0.25%. If you took out a $200,000 mortgage, for example, one point would cost $2,000 and get you a 0.25% discount on your interest rate. Two mortgage points would cost $4,000 and lower your interest rate by 0.50%.
What's the most points you can buy down on a mortgage? ›
How many points can you buy down the interest rate? There is no set limit for how many mortgage points you can purchase, but most lenders limit borrowers to four points. Due to state and federal limitations, there are restrictions on the amount a borrower can pay in closing costs on a mortgage.
Is it better to pay a bigger down payment or buy points? ›
Usually, it's better to apply any extra cash to your down payment than to points. A larger down payment may result in a lower interest rate, cheaper mortgage insurance (or no mortgage insurance) or lower monthly mortgage payments.
Can you buy down interest rate 2%? ›
In a 2-1 buydown, the interest rate is slashed by 2% in the first year, 1% in the second year and then returns to normal in the third. A mortgage with 6.25% interest would drop to 4.25% the first year, ratchet back up to 5.25% in year two and then return to 6.25% in year three.
Permanent Buydowns
This type of buydown lasts for the entire loan term. With a permanent mortgage rate buydown, you pay a fee known as discount points to lower your interest rate for the life of your loan. You can purchase as little as 0.125 of a point or as much as 4 points, depending on the loan program.
Who pays for rate buy down? ›
Mortgage rate buydowns typically happen in one of two ways: The seller contributes to the buyer's closing costs via discount points, or the seller pays for a temporary rate buydown.
Is buydown a good idea? ›
Permanent buydowns are more beneficial than price reductions for the buyer and the seller. Also called seller buydowns, they're better for buyers who plan on living in the same house for a long time.
What is a 321 buydown? ›
Key Takeaways. With a 3-2-1 buydown mortgage, the borrower pays a lower than normal interest rate over the first three years of the loan. The loan interest rate is reduced by 3% in the first year, 2% in the second year, and 1% in the third year; for example, a 5% mortgage would be just 2% in year one.
Can you refinance after a 2:1 buydown? ›
Refinancing is often used to secure a lower interest rate when market rates dip. It can also be used to cash out some of your home equity. You may be able to refinance your 2-1 buydown loan as long as the refinancing requirements relating to credit, income, equity, and payment history are met.
What is the downside of lowering interest rates? ›
Lowering rates makes borrowing money cheaper. This encourages consumer and business spending and investment and can boost asset prices. Lowering rates, however, can also lead to problems such as inflation and liquidity traps, which undermine the effectiveness of low rates.
Is a 2:1 buydown worth it? ›
Sellers, including home builders, may offer a 2-1 buydown to make a property more attractive to buyers. 2-1 buydowns can be a good deal for homebuyers, provided that they will be able to afford the higher monthly payments once those begin.
How does a 3/2/1 buydown work? ›
A 3-2-1 buydown temporarily lowers the interest rate on your mortgage by 3 percentage points the first year, 2 percentage points the second year, and 1 percentage point the third year. After that time, your mortgage will revert to the original rate.
How much is 1 point on a mortgage? ›
Mortgage points, also known as discount points, are a form of prepaid interest. You can choose to pay a percentage of the interest up front to lower your interest rate and monthly payment. A mortgage point is equal to 1 percent of your total loan amount. For example, on a $100,000 loan, one point would be $1,000.
