Interest Rate Buydowns are tools that can be used to reduce the monthly payments on a mortgage loan, either permanently, for the duration of the loan, or temporarily, for the first one-, two-, or three-years’ worth of payments. A Buydown can be an advantage for the seller as the residential real estate market swings to favor the buyer. It can also benefit the buyer when interest rates are on the rise. Both these market trends are currently volatile, but as interest rates rise, fewer people can afford to buy a home. As more homes become available in the market, sellers are potentially faced with the need to either reduce their selling price, or to make other concessions to speed up the sale.
During the recent housing boom, sellers merely had to list their home for sale and a bidding war would begin before there was even a “For Sale” sign in the front yard. As the housing 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 on the purchase of a home.
What is an Interest Rate Buydown?
Rising interest rates drive up monthly loan payments and drive down the number of people applying for a loan, especially those buying higher-priced homes. It may seem like the obvious solution would be for the seller to reduce the asking price of the home, but in many cases, a Seller-paid Interest Rate Buydown can result in a more advantageous transaction for both the buyer and the seller.
Your whole team – the seller, buyer, builder, real estate agent, and lender – will interact to ensure that all parties benefit from an agreement that meets their individual long-term needs. Neither the buyer nor the seller can make this decision without advice from mortgage experts, so read on to help you understand what the experts are talking about, and the pros and cons of Interest Rate Buydowns.
Who Benefits from A Seller-Paid Interest Rate Buydown?
Lenders allow the seller of a home to “credit” a portion of their proceeds back to the home buyer. This is called a seller concession. Seller concessions can be used to help pay a buyer’s closing costs, or they can also be used to cover the costs of an Interest Rate Buydown program.
A Seller-paid Interest Rate Buydown program offers benefits for all parties involved in the transaction because a lower interest rate on a mortgage loan:
- 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 reduced monthly payments made possible by a lower interest rate.
- Helps keep home values in the area higher by avoiding price reductions.
Two different types of Seller-paid Interest Rate Buydowns make it possible for the buyer and the seller to reach a financial agreement that benefits them both:
- Permanent interest Rate Buydowns, paid for with mortgage points
- Temporary Interest Rate Buydowns, paid for with fixed-dollar sales concessions
Permanent Interest Rate Buydowns
A Permanent Interest Rate Buydown allows homebuyers the opportunity to obtain a lower interest rate for the entire term of a mortgage loan. Seller concessions can be calculated in the form of mortgage points and used to permanently “buy down”, or reduce, the interest rate that is charged by the lender on the loan. These mortgage points, also referred to as discount points or prepaid interest points, are a one-time fee, paid upfront, with 1 point being equal to 1% of the loan amount.
Permanent Interest Rate Buydowns are a good option when the homebuyer plans to stay in the home for at least five years because the long-term savings on the monthly payments will exceed will the cost of the points. This is also a good option because the lower monthly payments that result from a Permanent Interest Rate Buydown allow the homebuyer to qualify more easily for the mortgage.
Temporary Interest Rate Buydowns
Seller concessions can also be used the reduce the interest rate on the mortgage loan for a shorter period at the beginning of the loan. For homebuyers who have a stable income that will grow over time, or who don’t plan on staying in the home for very long, using a seller concession for a Temporary Interest Rate Buydown might be a smarter choice because the monthly savings on the mortgage payment will typically be larger than with a Permanent Interest Rate Buydown, but only for the first one, two, or three years of the loan.
With a Temporary Interest Rate Buydown, the seller pays an upfront fee, called a Subsidy, which curtails the homebuyer’s monthly mortgage payments for the initial period of the loan. The Subsidy is placed into an escrow account and a portion of it is allocated, each month, to help reduce the homebuyer’s monthly payment on the loan. Choosing a Temporary Interest Rate Buydown when buying a home makes sense when the homebuyer wants to have the lowest possible monthly payment, in the short run, to help ease into home ownership.
The majority of Interest Rate Buydowns are negotiated between buyers and sellers and can benefit all parties to the transaction. Because mortgage rates are expected to continue rising in 2023, a Buydown can be a particularly useful tactic to protect the buyer against interest rate hikes.
Sellers may offer to give a sales concession to “buy down” the mortgage interest rate for the buyer in order to make the purchase more affordable. Interest Rate Buydowns can apply to the entire term of a mortgage, or for just a few years. While the seller gives a concession to pay for the Buydown only once, at the close of the sale, the buyer can save money on their monthly mortgage payments in either the short or the long run.
An Interest Rate 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 Mortgages (ARMs) for more information about this option.
Available Interest Rate Buydown programs vary by lender and the details can be complicated, so consult with your Citywide Loan Officer for help determining if an Interest Rate Buydown program is the right strategy for you.