A buydown mortgage, or mortgage rate buydown, is a strategy some lenders and homebuyers use to counter rising mortgage rates. While buydown mortgages have been used for years, lenders have been advertising them more often because they need to attract new homebuyers and create businesses for themselves. In an era where fewer homes are being sold, and mortgage lending is not as lucrative for banks as it once was, buydown mortgages are receiving renewed attention.
Here is what they are and how they can benefit you if you want a home mortgage.
Buydown Mortgages Provide a Lower Interest Rate Temporarily
A buydown mortgage is a type of mortgage financing wherein the buyer agrees to a lower interest rate for the first few years of a mortgage under an agreement that it will rise in the future. Lenders often arrange these mortgages to function as two or three parts where the interest rate starts low and rises appropriately within the structure set out.
How a Buydown Mortgage Works: 3-2-1 Buydown
A 3-2-1 buydown mortgage is your average. This means that a low-interest rate is locked in for year 1. For the first three years, the interest rate increases incrementally by 1% annually. The full interest rate that a homebuyer will pay then applies beginning with the fourth year of the mortgage loan. A 2-1 buydown mortgage works similarly, except it only applies to the first two years as opposed to the first three.
Look At the Terms of Your Buydown Mortgage to Understand More Closely
Buydown mortgages can work in a few different ways. There are also discount points that can lower a mortgage’s interest rate by paying an upfront fee. Be sure to look at your mortgage contract with a real estate lawyer or an expert to fully understand how a lender defines a buydown and to see what’s expected of you in the years ahead.
Think of Buydown Mortgages as a Subsidy That Helps You and the Lender
In a sense, a buydown mortgage is a subsidy to make the mortgage more affordable. It works because the seller contributes funds to an escrow account to help subsidize your mortgage in the first few years, lowering the monthly payment. Builders, sellers, and lenders can offer buydown mortgages to increase the chance of selling the property and make it more affordable to the average buyer.
You May Pay A Higher Cost In The Long-Term
If the builder or seller offers a buydown mortgage as part of the home-buying deal, they may increase the home’s total purchase price to compensate. To counteract this, a homebuyer may opt for an adjustable-rate mortgage to refinish once the initial rate term ends. This may assist them in locking in a better interest rate if they suspect interest rates will lower in the coming years.
Why Buydown Mortgages Are Worth It to Pursue for a Homebuyer
A homebuyer will pay less interest over the life of a loan, agreeing to a buydown mortgage. They also benefit immediately from a lower interest rate. For many buyers, it makes sense to inquire about a buydown mortgage, depending on the interest rate they qualify for and how long they plan to remain at the property they’re purchasing.
What to Consider If You Are Considering a Buydown Mortgage
No homeowner wants to be trapped with a mortgage that they cannot cover the cost of. For this reason, a buydown mortgage isn’t right for every buyer. A buyer has to consider the total cost of the home and mortgage, the amount they will save in interest over the initial term, and what they will be locked in to pay long-term about their estimated future income.
Risks of a Buydown Mortgage
If you don’t expect your income to increase in the years to come and can barely make ends meet, a buydown mortgage is an obvious risk you should not take. After the buydown rate ends, the monthly payment could be higher than anticipated, depending on interest rates. This would put you in a position where you’re forced to contribute more financially to your property or have to sell.
If You Don’t Plan To Stay In The Home, a Buydown Isn’t Right For You
The average homeowner can save tens of thousands of dollars with a buydown mortgage over their first few years. That said, if you aren’t planning on staying in your property for at least the next five years, a buydown mortgage isn’t likely to net you much in savings. It is a type of mortgage financing designed for the long-term customer who will hold on to a property for an extended period.
