Is a Buydown the Secret to a Lower Interest Rate?
Buying a home has always been expensive, but when interest rates are as high as they are today, becoming a homeowner can feel downright unattainable.While it might seem like the best strategy is to wait around and hope for lower mortgage interest rates in the future, our mortgage experts say otherwise. If you’re ready to buy a home now, there’s something you may be able to do to pave the way for more manageable mortgage payments.
The secret to buying a home in a high-rate market may be a buydown. In this article, discover how a buydown works, the difference between a temporary and permanent buydown, and how to decide if this option is right for you.
What is a Temporary Buydown?A temporary buydown is a financing option where a seller or builder contributes funds to an escrow account at closing, and each month, a portion of those funds are used to subsidize the buyer’s mortgage payment for a period of time. The result is a lower monthly payment for the buyer during the temporary buydown period. Generally, a temporary buydown can be used to reduce the monthly principal and interest payment for the first 1, 2, or 3 years, depending on the agreement.
How Does a Temporary Buydown Work?Since buydowns are negotiated between buyers and lenders, the structure of the buydown can vary depending on the specifics of each agreement. The party responsible for paying for the buydown (either the seller or builder) will pay the lender at closing the difference between the Note interest rate and the agreed to lower interest rate. This exchange is often referred to as “buying points”.
The buyer takes advantage of the lower interest rate until the buydown expires, at which point the effective interest rate will revert back to the interest rate established by the Note and the buyer’s monthly payments will increase. SouthState offers three different buydown options:
- 1-0 Buydown: This option allows for the effective rate of interest paid by the buyer to decrease 1% for the first year of the mortgage loan.
- 2-1 Buydown: The option allows for the effective rate of interest paid by the buyer to decrease 2% for the first year of the mortgage loan and 1% for the second year.
- 3-2-1 Buydown: This option allows for the effective rate of interest paid by the buyer to decrease 3% for the first year of the mortgage loan, 2% for the second year and 1% for the third year.
What is a Permanent Buydown?Unlike its temporary counterpart, a permanent buydown is a permanent interest rate reduction for the entire life of the loan. In this instance, the buyer, seller, or builder pays a lump sum to be used to buy down the interest rate for the life of the loan.
How Does a Permanent Buydown Work?The buyer, seller, or builder funds a permanent rate reduction by paying points to the lender at closing to buy a lower interest rate. The cost of a permanent buydown varies based on the loan program. One of our local Mortgage Bankers can talk with you about the bank’s various loan programs including those with the option to permanently buy down the rate.
What is the Difference Between a Permanent and a Temporary Buydown?While both solutions can help buyers reduce their mortgage interest rate, the ‘best’ solution is dependent on the buyer’s needs and unique circumstances. A temporary buydown may have a greater impact on monthly payments during the first few years of the mortgage, but a permanent buydown provides a long-term benefit. Ultimately, there are two key differences between a permanent and temporary buydown: the structure of the loan, and how a buyer qualifies for the loan.
Loan StructureFor a temporary buydown, money is contributed to an escrow account and used to fund monthly mortgage payments for the specified buydown period. With a permanent buydown, points are paid to the lender to permanently reduce the interest rate for the life of the loan.
Buyer QualificationsBecause a permanent buydown reduces the interest rate for the life of the loan, the borrower is able to qualify for the mortgage at the reduced rate. In the case of a temporary buydown, the borrower must qualify at the Note rate, rather than the lower rate in place during the buydown period.
When is It a Good Idea to Do a Buydown?Many Americans are struggling to buy a home right now due to a combination of recent interest rate volatility and increased home values, two factors which will likely continue. If when you’re ready to buy a home, market conditions aren’t in your favor, consider negotiating a permanent or temporary buydown with your seller to help offset your mortgage costs.
The most favorable time to take advantage of a buydown is when the seller or builder is offering to contribute cash towards closing. Sometimes this can happen as an incentive to get a buyer to purchase their home or to encourage the purchase of a home in a newly built community. If this isn’t an option, a buyer can often still pay down the rate themselves, but we recommend careful consideration when determining if this is a good option for you. If purchasing points as a buyer, you will need to be prepared to fund a down payment, closing costs, as well as the cost of each point purchased.
A temporary buydown can be beneficial if you’re expecting your income to be significantly higher in the near future, or if you don’t plan to own the home very long. A permanent buydown is likely more advantageous if you do not foresee a major salary increase or if you plan to stay in your home long-term.
A buydown is a tool that helps buyers navigate high interest rate market conditions by lowering their monthly mortgage payments either temporarily or permanently. While lowering your interest rate can lead to long-term savings, a buydown is not for everyone. If you’re considering buying down your mortgage interest rate, you can use a calculator to see if the upfront investment is worth your while.
Don’t let the housing market and current interest rates prevent you from buying a home, contact a Mortgage Banker today to see if a buydown could work for you.
About the Author, Lauren Rogers, NMLS #1434981: Lauren Rogers, a Charleston native, began her career at SouthState in 2012. After several years in the Capital Markets department, her expertise includes secondary market risk analysis and product development. A graduate of the College of Charleston, she holds a degree in Business Administration with a concentration in Finance. When not working with clients, Lauren volunteers with Trident United Way and is a member of the College of Charleston Alumni Association.