Although many home searchers tend to hyper-focus on a home’s sticker price, the impact of the mortgage rate is equally important. A great rate can shave hundreds of dollars off the monthly mortgage payment, while a high rate can push a home out of reach. Now that rock-bottom rates of 2% and 3% are firmly in the rearview mirror, it’s time for buyers to educate themselves on their options.
What is a mortgage buydown?
A mortgage buydown occurs when a homebuyer (or a seller, on their behalf) pays an upfront fee to a lender in exchange for a lower interest rate on their mortgage loan.
This upfront payment effectively reduces the borrower’s monthly mortgage payments.
Buydowns are often used to make homeownership more affordable in the early years of ownership, especially when interest rates are relatively high. They can be structured in various ways, such as 2-1 or 3-2-1 buydowns. A 3-2-1 buydown, for example, means your rate is reduced by 3% the first year, 2% the second year, and 1% the final year—allowing you to gradually adjust to your full rate.
However, buyers can also opt to buy down their rates for the entirety of the loan term—meaning they get a lower mortgage rate for life. This is known as buying mortgage points.
How much does it cost to buy down your interest rate?
The cost of a 3-2-1 or 2-1 loan is calculated as the difference between the total payments made at the original monthly payment, and the total payments made at the rate-adjusted monthly payments.
For mortgage points, the cost varies (depending on the loan, the lender, etc.) but generally, it costs 1% of the loan amount to receive each “point”, and each point buys a .25% rate reduction. So for a $400,000 loan, reducing the interest rate 1% will cost 4% of the loan amount—or $16,000.
Pros and cons of buying down the mortgage rate
Like any financial choice, there are costs and benefits associated with buying down your mortgage rate.
3-2-1 and 2-1 rate buydown
Benefits:
- Homebuyers can get a reprieve from high interest rates, allowing them to pay a lower monthly payment for the first 2 to 3 years of home ownership without being penalized
- Temporary buydowns give homeowners a couple years to save up money and/or increase their earnings, making it easier to pay for the mortgage once the full amount is due
- Sellers and builders are often willing to pay for temporary buydowns
- Gives buyers a couple years to see if the rates will come down (allowing them to refinance)
- It can help free up cash for buyers who need to deal with large, upfront costs (like fixing a roof, or landscaping) when they initially move in
Drawbacks:
- Once the temporary 2 or 3 year period is over, buyers are stuck with the higher rate for the entirety of the loan (or until they refinance)
- There is an upfront cost to receiving a temporary rate buy down
- Buyers who are not careful with their money may struggle to make payments once the full mortgage rate kicks in
30-year rate buy down
Benefits:
- The buyer can save money every month over the lifetime of the loan
- Buyers who plan to stay in the home for the majority of the 30-year loan stand to see significant savings
- Buyers pay less in interest every year and build equity faster
Drawbacks:
- Expensive—1% of home price buys down .25% of the loan
- For buyers who plan to stay in their home only an average length of time (under 10 years), buying down the rate may not save them as much money as increasing their down payment
- Not always necessary—if the rate eventually falls on its own, it can be cheaper for buyers to just refinance their loan then
How do I negotiate a rate buydown?
Many sellers offer rate buydowns in the listing description of their home, which means you don’t need to do any work. Your Realtor can help you find homes that offer this—you can also do a keyword search on sites like Redfin for terms like “rate” “buydown” and “financing” to find the relevant listings.
Typically if the seller doesn’t offer it outright, buyers will request it in their initial offer—just ask your Realtor to include this. Some buyers will try to make their offer more appealing in other ways, by removing contingencies, allowing a seller rentback, offering the full asking price, etc.
Of course, the seller might counter your offer and drop the rate buydown—but you can choose whether or not you want to accept. In today’s environment, many sellers are willing to do what ti takes to lock in a qualified buyer.
I Can Buy Down My Mortgage Rate, But Should I?
There are both pros and cons to buying down your mortgage rate. If the seller offers you a 2-1 or 3-2-1 buydown, this is often the best scenario—the money isn’t coming out of your pocket, and it gives you several years to save up money (and see whether a better rate hits the market). Buying down your 30-year rate, meanwhile, is best for buyers who plan on staying in their home for the majority of the loan term.
