Buydowns as a Strategy to Lower Interest Rates
In a nutshell, a buydown is a way to lower the interest rate on a mortgage loan, either for the duration of the loan or for the first two or three years. A buydown can be an advantage for the seller as the market swings to favor the buyer. It can also benefit the buyer when interest rates are on the rise. Both of these market trends are currently volatile. As interest rates rise, fewer people can afford to buy a home. As more homes become available, sellers are faced with the need to possibly lower their price or make other concessions to speed up the sale.
During the recent housing boom, sellers only had to say their home was for sale and a bidding war would start before there was even a sign in the front yard. As the market shifts, due mostly to rising interest rates, homes are taking longer to sell and buyers want to negotiate, hoping to get a better deal.
Two different types of buydowns make it possible for the buyer and the seller to make a financial agreement that benefits both of them:
- The seller-paid rate buydown
- A borrower buydown paid for with mortgage points
Sellers and builders can also be responsible for purchasing points to lower the buyer’s interest rate. Your whole team—seller, buyer, builder, real estate agent, lender—will interact to ensure that everyone benefits from an agreement that meets their long-term needs. Neither the buyer nor the seller can make this decision without advice from mortgage experts.
To help you understand what the experts are talking about, read the following information about types of buydowns and their pros and cons.
What Is a Seller-Paid Rate Buydown?
Rising interest rates drive up monthly loan payments and drive down the number of people applying for a loan, especially to buy higher-priced homes. It may seem like the obvious solution is for the seller to reduce the asking price of the home, but in many cases, a seller-paid rate buydown, or reduction in interest rates, actually results in more profit for both the buyer and the seller.
The whole idea for the seller-paid rate buydown is to get money back from the seller to permanently buy down the interest rate.
Lenders allow the seller of a home to “credit” a portion of their proceeds to the home buyer. This is called a seller concession. Seller concessions can be used to help pay a buyer’s closing costs and can also be used to pay for mortgage points to buy down the interest rate. Mortgage points, also referred to as discount points or prepaid interest points, are a one-time fee paid upfront. In some agreements, the interest rate is lower for the loan term. The points purchased may also reduce the interest rate for a given amount of time at the beginning of the loan.
Who Benefits from A Seller-Paid Rate Buydown?
A seller-paid rate buydown offers benefits for all parties involved in the long run. A below-market interest rate:
- Entices more buyers.
- Is more profitable for the seller upfront than lowering the asking price. (Ask an expert to explain how.)
- Saves the buyer money with lower payments made possible by the lower interest rate.
- Helps keep home values up in the area by avoiding a price reduction.
What Is a Borrower Buydown?
A borrower buydown is a way to obtain a lower interest rate on a mortgage loan by paying mortgage points or a one-time fee upfront at closing. The lender reduces their interest rate as a result. Smart buyers weigh the cost of the buydown points against the monthly savings that come from lower payments. Because mortgage rates are expected to continue rising in 2023, a buydown can be a tactic that protects the buyer against rate hikes.
What Are the Benefits of a Borrower Buydown?
- A buydown allows homebuyers to obtain a lower interest rate when taking out a mortgage loan.
- This lower payment allows the homebuyer to qualify more easily for the mortgage.
- Buydowns can save homeowners money on interest for the first two or three years or even over the life of the loan, depending on the buydown agreement.
- A buydown involves purchasing discount points against the mortgage loan, which requires payment of an up-front fee.
- Whether it makes sense to choose a buydown when buying a home can depend on the interest rate for which you qualify and how long you plan to remain in the home.
When to Use a Buydown
- If it allows you to get a mortgage without significantly increasing the purchase price of the home or draining your cash reserves.
- If you have a stable income that will grow over the life of the loan, making it easier to keep up with payment increases once the initial lower-rate period ends.
- If the interest rate for which you qualify makes a buydown is worth it.
- If you plan to stay in the home for at least five years, and the savings exceed will the cost of the points.
- If the seller or homebuilder pays for the buydown without raising the price of the home.
Summary
The majority of buydowns are negotiated between buyers and lenders. Buydowns can apply to the entire term of a mortgage or for just a few years. The terms vary by lender. The cost for each discount point depends entirely on the amount you, the borrower, take out on the loan. The average cost for each point is about 1% of the loan amount.
Sellers may offer to buy down a buyer’s mortgage rate to make the purchase more affordable. The seller makes the one-time payment and deposits it into an escrow account or pays for points over the loan term as a seller concession.
Buydowns mean that more money is paid upfront so the buyer can save money in the long run. Buydowns are only practical if the buyer intends to own the home for an extended period of time.
A buydown is not the same as an adjustable-rate mortgage (ARM), in which the rate is fixed for a set period of time before adjusting to a variable rate. See our article Adjustable-Rate Mortgage (ARM).
Consult with your Citywide loan officer for help determining if a buydown is the right strategy for you and your mortgage loan.