INTEREST RATE BUYDOWNS
An interest-rate buydown is a financing arrangement that can reduce a borrower’s mortgage payments temporarily or lower the loan’s interest rate for its entire term. Buydowns may make the early years of homeownership more manageable, but borrowers must understand how the payments will change and what the loan will ultimately cost.
There are two primary types of buydowns:
TEMPORARY BUYDOWN
A temporary buydown reduces the borrower’s principal-and-interest payments for a limited period—typically one to three years. The mortgage’s actual note rate generally remains unchanged. Money placed into a subsidy account covers the difference between the temporarily reduced payment and the payment required at the full note rate.
Depending on the loan program and transaction, the buydown may be funded by the seller, builder, lender, employer, buyer, or another permitted party. Contribution limits and lender requirements may apply.
HOW A 2-1 BUYDOWN WORKS
A 2-1 buydown generally provides:
• Year 1: Payments calculated as though the interest rate were 2 percentage points below the note rate.
• Year 2: Payments calculated as though the interest rate were 1 percentage point below the note rate.
• Year 3 and thereafter: Payments based on the full note rate for the remainder of the loan.
For example, if the mortgage has a 7% fixed note rate:
• Year 1 payments would be calculated as though the rate were 5%.
• Year 2 payments would be calculated as though the rate were 6%.
• Beginning in Year 3, payments would be based on the full 7% note rate.
This example applies only to principal and interest. Property taxes, homeowners insurance, mortgage insurance, homeowners association fees, and other housing expenses may change independently.
HOW A 3-2-1 BUYDOWN WORKS
A 3-2-1 buydown generally provides:
• Year 1: Payments calculated as though the rate were 3 percentage points below the note rate.
• Year 2: Payments calculated as though the rate were 2 percentage points below the note rate.
• Year 3: Payments calculated as though the rate were 1 percentage point below the note rate.
• Year 4 and thereafter: Payments based on the full note rate.
The actual cost of a temporary buydown is based on the amount needed to cover the difference between the reduced payments and the full payments during the buydown period. It is not automatically equal to a particular number of mortgage points.
PERMANENT BUYDOWN
With a permanent buydown, discount points are paid at closing in exchange for a lower note rate for the life of the loan. One discount point generally equals 1% of the loan amount, but the amount by which a point reduces the interest rate is not fixed. It varies by lender, loan program, market conditions, and the date the rate is quoted.
A permanent buydown may be worth considering when a buyer expects to keep the mortgage long enough for the monthly savings to exceed the upfront cost. Buyers should ask the lender to calculate the break-even period before making a decision.
IMPORTANT THINGS TO KNOW
• A temporary buydown does not automatically allow a buyer to qualify for a larger mortgage. Many loan programs require the borrower to qualify using the full note rate and payment.
• Buyers should be comfortable making the full payment before agreeing to a temporary buydown.
• The payment reduction is temporary. It is important to plan for each scheduled increase.
• Refinancing before the full payment begins may be possible, but refinancing is never guaranteed. Future interest rates, property value, income, credit, and lender requirements will determine eligibility.
• Seller or builder contributions toward a buydown may be subject to loan-program limits.
• Mortgage points are not automatically tax deductible. Their tax treatment depends on several factors, including the type of points, who paid them, the property and loan, and whether the taxpayer itemizes deductions. Consult a qualified tax professional for advice.
• First-time-buyer programs, down-payment assistance, and state or local housing programs may offer valuable benefits, but they are not necessarily interest-rate buydowns. Eligibility requirements vary.
• Before selecting a buydown, compare it with other possible uses of available funds, such as reducing the purchase price, paying closing costs, making a larger down payment, or completing necessary repairs.
IS A BUYDOWN RIGHT FOR YOU?
A buydown may be helpful when a buyer wants lower initial payments and can comfortably afford the full payment when the temporary subsidy ends. Whether it is a good financial choice depends on the cost of the buydown, the loan terms, the buyer’s future plans, and how long the buyer expects to keep the mortgage.
A licensed mortgage professional can explain available programs, calculate the payment for each year, disclose the full cost, and determine whether the borrower qualifies.
YOUR REAL ESTATE RESOURCE
Susie Schmitt
REALTOR® | Associate Broker
Military Relocation Professional
Tierra Antigua Realty
(520) 508-6239
www.susieschmitt.com
Susie can help you explore available properties, prepare a competitive offer, and discuss whether requesting seller concessions may support your homebuying goals. A licensed mortgage professional must provide and explain specific loan programs, rates, payments, costs, and qualification requirements.