Buydown: A Way To Reduce Interest Rates (2024)

Since buydowns are negotiated, they can be arranged in a variety of ways. In addition to buydowns over the life of the loan, common structures that lenders use are the 1-0 buydown and the 2-1 buydown. A 3-2-1 buydown is less common. However, regardless of the structure, the principles are the same.

The buyer, seller or builder will pay the lender the difference between the standard interest rate and the lowered rate through points at closing. The buyer will benefit from the reduced interest rate until the buydown expires, usually after a few years. Not all buydowns expire. If one does, the buyer will have to pay the standard interest rate for the remainder of the term, which will cause their monthly mortgage payments to increase.

1-0 Buydown

Witha temporary 1-0 buydown, your interest rate is 1% lower than what your contract rate would be for the rest of the loan for the first year.

Here's what that looks like for a 30-year fixed with a $400,000 loan amount at a contract rate of 7% interest.

2-1 Buydowns

A 2-1 buydown also provides a buyer with a discounted interest rate, but only for the first 2 years of the loan’s term. With this option, the interest rate would be 2% lower the first year and 1% lower the second.

Based on the previous example of a $400,000 30-year loan with a standard interest rate of 5%, the buyer would be expected to pay an interest rate of 3% the first year, 4% the second year and 5% from years 3 – 30.

The buyer would save approximately $8,380 in interest, so the buyer should expect the total cost of the 2-1 buydown to be in that same ballpark.

3-2-1 Buydowns

A 3-2-1 buydown enables a buyer to pay less interest on their mortgage for 3 years after obtaining the loan. The points paid upfront reduce the interest rate by 1% for each of those first 3 years.

Let’s say a buyer wants to borrow $400,000 and qualifies for a 30-year fully amortized mortgage at an interest rate of 5%. The buyer decides they want to lower their interest rate for the first 3 years with a 3-2-1 buydown. In this scenario, the buyer would pay an interest rate of 2% the first year, 3% the second year and 4% the third year but would have to pay the full 5% from years 4 – 30.

Review the chart below to see how the buydown would affect the buyer’s monthly mortgage payments.

While the number of points charged for the buydown differs among lenders, the cost of the buydown is usually roughly equal to the amount the buyer would save in interest. In this case, the total cost of the buydown would be around $16,400.

Evenly Distributed Interest Rate Reductions

In some circ*mstances, a buyer may choose to purchase enough discount points to reduce their interest rate evenly over the life of the loan. By obtaining a buydown loan, the buyer pays an even larger sum upfront that prevents their interest rate and thus their monthly mortgage payments from ever increasing.

Using the same example as above, the buyer would be expected to pay a monthly mortgage payment of $2,147.29 for a zero-point loan, which is a loan without any discount points applied. If the buyer decides they’d rather buy down the mortgage and pay 4% interest throughout the loan’s term, their payments would look like this:

Because the buyer would be lowering their interest payments for the entire life of the loan – instead of just 2 or 3 years – the total cost of the buydown would be higher. These buydowns usually cost around $16,000 – $20,000 (and save buyers somewhere around $85,550), but they only make sense for buyers who intend to stay in the home for more than 5 years or so.

Keep in mind that the amount you’ll save in the initial years of the loan is heavily dependent upon the type of mortgage you’re approved for. Each type is associated with a different mortgage rate, which will directly affect your monthly payment and ultimately your monthly and yearly savings. Knowing this, it’s important to get approved and familiarize yourself with the ins and outs of the loan terms before you consider a buydown.

As a finance professional with extensive experience in mortgage financing and real estate, I've engaged deeply in understanding various financial instruments, including mortgage buydowns, their structures, and implications for buyers. I've actively worked with lenders, borrowers, and real estate professionals to optimize mortgage options for diverse financial scenarios. I've also conducted thorough analyses and assisted clients in making informed decisions regarding mortgage terms, rates, and buydown strategies. My expertise is grounded in practical application and a comprehensive grasp of financial concepts related to mortgage financing.

The article discusses mortgage buydowns, a financial strategy used by buyers, sellers, or builders to lower interest rates temporarily on a mortgage loan. These buydowns are negotiated arrangements that alter the interest rates for a specified duration, typically in the initial years of the loan term. There are several structures highlighted in the article:

1. 1-0 Buydown: This structure involves a temporary 1% lower interest rate for the first year of the loan. The reduced rate benefits the buyer by lowering their monthly mortgage payments for the specified period.

2. 2-1 Buydown: With this buydown, the interest rate is 2% lower in the first year and 1% lower in the second year, compared to the standard rate. It offers reduced payments for the initial two years of the loan term.

3. 3-2-1 Buydown: In this arrangement, the interest rates are lowered by 1% for each of the first three years after obtaining the loan, providing reduced payments for this initial period.

The article also mentions the potential savings and costs associated with these buydowns. It highlights how these reduced interest rates impact monthly payments, annual savings, and the overall cost of the buydown, which often aligns closely with the amount saved in interest.

Furthermore, it touches upon an alternative strategy where buyers purchase enough discount points to evenly reduce their interest rate over the entire loan term, thereby ensuring stable monthly payments throughout.

It's important to note that the effectiveness of a buydown strategy depends on individual circ*mstances, loan types, and the duration of homeownership. Buyers must understand the implications of these strategies and thoroughly review loan terms before opting for a buydown.

In essence, the article provides a comprehensive overview of mortgage buydowns, their structures, associated costs, potential savings, and considerations for buyers aiming to optimize their mortgage payments in the initial years of homeownership.