What is a mortgage rate buydown and how does it work?

Rising mortgage rates have pushed potential home buyers to the sidelines and slowed home sales. In an effort to simulate the sluggish market, both sellers and mortgage lenders have begun to woo would-be homeowners with rate buydowns and discount points that make home loans more affordable for buyers.

“Those kinds of products have been around and typically only get utilized when lenders are desperate to create a need for a consumer,” says Gordon Miller, president of North Carolina-based Miller Lending Group.

So before you use a rate buydown or discount points to lower the interest rate on your mortgage, it’s important to understand how they work and when it makes sense for you.

How does a mortgage rate buydown work?

Buydowns and discount points (otherwise known as mortgage points) are both ways to lower your mortgage’s interest rate by paying extra money when you take out the mor. The terms are sometimes used interchangeably, so it’s important to understand how your individual mortgage lender is defining the buydown. “Make sure you get a copy of the [mortgage] note itself. So that [way] you understand fully all the terms and/or restrictions of the buydown,” Miller says.

What are discount points?

When you pay for discount or mortgage points, you permanently lower your mortgage’s interest rate (as opposed to buydowns which only temporarily lower the rate).

You’ll generally pay 1{ac23b82de22bd478cde2a3afa9e55fd5f696f5668b46466ac4c8be2ee1b69550} of the total loan amount for each point and receive a 0.25{ac23b82de22bd478cde2a3afa9e55fd5f696f5668b46466ac4c8be2ee1b69550} rate reduction, but the cost and discount vary depending on the market and lender. “What you get with one point from one lender could be worlds different than with another lender,” says Jennifer Beeston, mortgage educator and senior vice president at Guaranteed Rate.

What are temporary buydowns?

A temporary buydown lowers the interest rate to a certain percentage, which then increases each year until it returns to the original rate. Common temporary buydown terms are 2-1 and 1-0, where the first number is the rate reduction you receive in the first year and the second number is the rate reduction for year two.

With a 2-1 buydown, a 6.25{ac23b82de22bd478cde2a3afa9e55fd5f696f5668b46466ac4c8be2ee1b69550} mortgage rate would be cut to 4.25{ac23b82de22bd478cde2a3afa9e55fd5f696f5668b46466ac4c8be2ee1b69550} the first year, increase to 5.25{ac23b82de22bd478cde2a3afa9e55fd5f696f5668b46466ac4c8be2ee1b69550} in year two and return to 6.25{ac23b82de22bd478cde2a3afa9e55fd5f696f5668b46466ac4c8be2ee1b69550} in the third year. Here’s what that looks like for a $350,000 loan balance.

Mortgage rate buydown example

Interest rate Monthly payment Monthly savings Yearly savings
Year 1 4.25{ac23b82de22bd478cde2a3afa9e55fd5f696f5668b46466ac4c8be2ee1b69550} $1,722 $433 $5,196
Year 2 5.25{ac23b82de22bd478cde2a3afa9e55fd5f696f5668b46466ac4c8be2ee1b69550} $1,933 $222 $2,664
Year 3 6.25{ac23b82de22bd478cde2a3afa9e55fd5f696f5668b46466ac4c8be2ee1b69550} $2,155 $0 $0

A temporary buydown is typically paid for by either the seller, homebuilder or lender and it effectively offsets a portion of the buyer’s monthly payment. From the example above, it would cost $7,860 for the full 2-1 buydown, which is the total amount the buyer saves. The money used to lower the buyer’s monthly payments is deposited into an account and taken out each month by the mortgage loan lender. Keep in mind, with a temporary buydown the borrower needs to qualify for the home loan based on the full interest rate after the buydown expires.

Regardless, of whether or not a rate buydown makes sense for your situation, you want to ensure you’re getting the best deal from the start. And if you’re not comparing offers from multiple mortgage lenders, there’s a good chance you’re leaving money on the table. Select ranked the lenders below as some of the best mortgage lenders on the market:

Rocket Mortgage

  • Annual Percentage Rate (APR)

    Apply online for personalized rates

  • Types of loans

    Conventional loans, FHA loans, VA loans and Jumbo loans

  • Terms

    8 – 29 years, including 15-year and 30-year terms

  • Credit needed

    Typically requires a 620 credit score but will consider applicants with a 580 credit score as long as other eligibility criteria are met

  • Minimum down payment

    3.5{ac23b82de22bd478cde2a3afa9e55fd5f696f5668b46466ac4c8be2ee1b69550} if moving forward with an FHA loan

SoFi

  • Annual Percentage Rate (APR)

    Apply online for personalized rates; fixed-rate and adjustable-rate mortgages included

  • Types of loans

    Conventional loans, jumbo loans, HELOCs

  • Terms

  • Credit needed

  • Minimum down payment

Pros

  • Fast pre-qualification
  • Provides access to Mortgage Loan Officers for guidance
  • $500 discount for existing SoFi members
  • 0.25{ac23b82de22bd478cde2a3afa9e55fd5f696f5668b46466ac4c8be2ee1b69550} price reduction when you lock in a 30-year rate for a conventional loan
  • Offers up to $9,500 cash back if you purchase a home through the SoFi Real Estate Center

Cons

  • Doesn’t offer FHA, VA or USDA loans
  • Mortgage loans are not available in Hawaii

Ally Bank Mortgage

  • Annual Percentage Rate (APR)

    Apply online for personalized rates; fixed-rate and adjustable-rate mortgages included

  • Types of loans

    Conventional loans, HomeReady loan and Jumbo loans

  • Terms

  • Credit needed

  • Minimum down payment

    3{ac23b82de22bd478cde2a3afa9e55fd5f696f5668b46466ac4c8be2ee1b69550} if moving forward with a HomeReady loan

Pros

  • Ally HomeReady loan allows for a slightly smaller downpayment at 3{ac23b82de22bd478cde2a3afa9e55fd5f696f5668b46466ac4c8be2ee1b69550}
  • Pre-approval in just three minutes
  • Application submission in as little as 15 minutes
  • Online support available
  • Existing Ally customers can receive a discount that gets applied to closing costs
  • Doesn’t charge lender fees

Cons

  • Doesn’t offer FHA loans, USDA loans, VA loans or HELOCs
  • Mortgage loans are not available in Hawaii, Nevada, New Hampshire, or New York

What you need to know before buying a lower mortgage rate

Understanding how discount points and rate buydowns work is essential when you’re shopping for a mortgage. A lender may offer an exceptionally low rate, only to have discount fees built into the deal. So you’ll want to pay attention to all aspects of the loan, not just the rate.

“Hardcore rate shoppers, they put zero value on service, expertise, education, they just are so rate focused that often they end up with the worst deal,” Beeston says.

If you’re paying for a discount, it’s important to always understand what you’re getting in return. Paying for a lower rate over the full 30-year loan term may look like it’ll save you money in the long run, but that doesn’t account for how likely you are to sell the home, refinance your loan or pay off your mortgage early. In each of those cases, the fees you pay upfront could end up being higher than what you saved. And researchers have shown that “borrowers overestimate how long they will stay with the mortgage.”

A temporary buydown can make sense since the buyer isn’t the one paying for it. However, even in that scenario, a buydown could come at the cost of other seller concessions. So you’ll want to consider the tradeoffs by asking yourself these three questions:

1. Could you get the same rate by refinancing later?

Whether or not you can refinance depends on several factors, including the type of mortgage.

For conventional loans, you’ll need at least 5{ac23b82de22bd478cde2a3afa9e55fd5f696f5668b46466ac4c8be2ee1b69550} equity (loan-to-value of 95{ac23b82de22bd478cde2a3afa9e55fd5f696f5668b46466ac4c8be2ee1b69550}) for a rate and term refinance, but you’ll typically only get the best rates if you have 20{ac23b82de22bd478cde2a3afa9e55fd5f696f5668b46466ac4c8be2ee1b69550} equity in your home or more. Right now there are very few cases where it makes sense to buy down the rate, Beeston says. However, if the borrower took out a conventional loan with 3{ac23b82de22bd478cde2a3afa9e55fd5f696f5668b46466ac4c8be2ee1b69550} down, “I think it can make sense because if rates drop they likely will not have enough equity to refinance immediately.”

There are streamlined refinancing options for both FHA and VA loans, which can make refinancing simpler with these loans than with a conventional loan. So it may make less sense for these types of borrowers to pay for a lower rate. “The last thing I want is my veterans spending a nickel to buy down a rate that they’re likely to refinance within the next year because then it’s just lighting money on fire,” she says.

Every time you refinance you have to consider the upfront closing costs. Your exact closing costs vary depending on the lender, the loan, where you live and the amount you’re borrowing. But refinance fees are thousands of dollars on average and can easily wipe out any potential savings you get by securing a lower rate.

However, you may be able to negotiate with the lender to receive credits to cover your fees in exchange for a higher interest rate. Lender credits are essentially reverse discount points and you may be able to use them to avoid fees when you refinance.

2. What are you giving up for the buydown?

Recently the housing market has shifted and sellers are working harder to entice buyers. “Because of the market we’ve been encouraging our clients to get the seller to pay closing costs, and we’ve had really good success with that,” Beeston says.

Just keep in mind that when sellers offer a buydown, that money has to come from somewhere. And funding the buydown might come at the cost of the seller reducing the overall purchase price or paying for closing costs. Depending on your preferences and financial situation, those concessions may be more important to you than a buydown.

3. Is this a good deal without the discount?

With any sort of buydown or discount points, you’ll want to ensure the starting rate is a good deal. Always compare loan offers from multiple lenders to ensure any discount is based on the best deal you can qualify for.

“Never get one [quote] because the industry can operate like a bad flea market,” Miller says. And be wary of any lender that is willing to price match because, “that’s more a game of, Oh, I guess you called someone else and found out I was charging too much. Okay. Got me. I’ll match it,” Miller says.

Bottom line

With mortgage rates sitting at twice what they were just over a year ago, it can be tempting to do everything in your power to get a lower rate. But your interest rate is only one aspect of your home loan and the home-buying process in general. You’ll want to pay attention to your mortgage’s closing costs because the fees you pay can wipeout the potential savings from securing a lower mortgage rate.

If you’re considering taking advantage of a rate buydown or discount points, be sure you fully understand what you’re getting, what it costs and what you may have to give up to get it.

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Editorial Note: Opinions, analyses, reviews or recommendations expressed in this article are those of the Select editorial staff’s alone, and have not been reviewed, approved or otherwise endorsed by any third party.