If you are looking to buy a home but can’t afford the house you’d like due to rising interest rates, there could be an easy way to lower your rate. Depending on how much money you have available for a down payment and closing costs, you can request a mortgage rate buydown from your lender.
Keep in mind, you’ll need some extra cash to buy down your mortgage rate, but it may pay off in the long run in comparison with putting the same amount of money toward a bigger down payment.
The question at hand is: What is a mortgage rate buydown — and how can it help reduce not just your monthly payments, but the overall cost of your mortgage?
What Is a Mortgage Rate Buydown?
When you complete a mortgage rate buydown, you will buy “points” at closing that will reduce your interest rate.
Permanent Mortgage Rate Buydown
When you use a permanent rate buydown to reduce interest costs, your interest rate will remain at the lower rate for the life of the loan, unless you take out an adjustable rate mortgage (ARM). In that case, your rate may rise, but it would not rise as much as it would have without the buydown.
You can do a buydown by purchasing mortgage points, sometimes called discount points, on your loan at closing. A mortgage point typically costs around 1% of your mortgage loan amount, according to GOBankingRates, and reduces your interest rate by 0.25%. So, if you put down an extra 4% in the form of purchasing 4 points, you could reduce your interest rate by a full percentage point.
It’s important not to confuse buydown points with mortgage origination points. Mortgage origination points also cost 1% of your mortgage, but they don’t directly lower your interest rate. Instead, these fees go to lenders to cover the costs or loan origination, review, and processing.
However, if you have limited money for closing and wish to forgo origination points, you could negotiate with lenders for a higher interest rate instead of those points.
Temporary Mortgage Rate Buydowns
Temporary mortgage rate buydowns are a little more complicated but can help borrowers afford a home by reducing interest rates dramatically for up to three years.
A 3-2-1 mortgage buydown offers an interest rate of 3% lower than the average rate at the time (which is, of course, also based on your credit history, income, and other factors). For instance, if rates are averaging 6% for someone in your situation, you could get a 3% interest rate… but only for the first year. For the second year, your rate will go up to 4%, and for the third year, you’ll pay 5%. By year 4, and for the rest of the mortgage term, you’ll pay the prevailing 6% rate.
You’ll want to compare the buydown price to your savings over three years to determine if a temporary mortgage buydown makes fiscal sense for you.
At the end of three years, if your credit is good and interest rates have dropped, you can refinance for a better rate.
A 2-1 temporary buydown follows the same format, but the lower rate only lasts for two years.
Should You Look for a Mortgage Rate Buydown?
Mortgage buydowns can be an effective tool to lower your monthly mortgage payments when interest rates are high. You’ll want to make sure you plan to stay in your home long enough — without refinancing — that you will recoup the cost of points you paid for upfront. And, of course, you’ll want to make sure you can afford to buy points in the first place.
You can use your savings, gift funds, or even ask the seller to pay the buydown, although, in today’s competitive sellers’ market, seller concessions aren’t as common.
Weigh the pros and cons and, if you opt for a temporary mortgage buydown, be sure you can afford the mortgage at the higher interest rate in two or three years.
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