A buydown or a buy-down is a financing technique in real estate where the borrower tries to get a lower interest rate for the first few years of the mortgage, at the very least. If possible, a buyer would attempt a buydown for the entire life of a home loan.
A buy-down mortgage is ideal for homebuyers who don’t quite meet the lender income requirements. With this buy-down option, they can obtain a home loan with lower interest rates and lower monthly payments.
How does a buy down mortgage work?
When fees are paid at closing directly to the lender in exchange for a lower interest rate, mortgage points or discount points are earned.
One point costs 1% of the mortgage amount. So for every $100,000, 1 mortgage point will cost $1,000. The more points you make the lower your monthly mortgage payments. This option is ideal if you plan to own the home for long term, giving you enough time to earn more points and save on interest over the life of the loan.
For a loan amount of $200,000, for example, your monthly payment with an APR of 4.5% and without mortgage points will be $1,013.37. For a 30-year loan, you will earn 0 total payment savings.
But, if you have 1 mortgage point that costs $2,000 and with an APR of 4.25%, your monthly payment is only $983.88. You will have a monthly payment savings of $29.49 or a total of $10,616.40 for the entire 30-year loan.
If you buy down 2 points for a total of $4,000 and with an APR of 4%, your monthly payment will only cost you $954.83. The monthly payment saving you will make is at $58.54 or a total of $21,074.40 for 30 years. For both 1 and 2 mortgage points, you will break even or be able to recover the cost of points in 68 months.
Types of Buy-Down
This is suitable for when you expect your income to increase in a few years or if you will be able to pay down a significant amount of debt that is currently tied down with your income. This is often used in the 3-2-1 buydown structure where you make an upfront payment that will help reduce the interest rate by 3% in the first year, 2% in the second year, and 1% in the third year.
This applies to the option discussed above, where mortgage points are earned when you pay fees at closing to the lender. It is important to have enough funds to pay for the points, closing cost, and down payment.