Many hopeful homeowners today are experiencing an affordability issue when it comes to financing a new home. Due to recent rate hikes from the Federal Reserve, interest rates have simply become too high for some buyers to be able to qualify for mortgages on properties they could have easily afforded in the past. And that's not all they're up against. Rising rates, declining property values, and inflation have all contributed to this unfolding crisis.
Fortunately, there's a creative solution that some borrowers can take advantage of when it comes to getting a lower interest rate: a buydown. All you need is a little know-how and a few extra dollars in your bank account. Read on to learn everything you need to know about an interest rate buydown, including how to get one and whether it's the right choice for your financial situation.
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Buydowns: Quick Tips to Know
- When you purchase a buydown, you are paying money to reduce an interest rate on a loan.
- A buydown is helpful when you are trying to buy a home and are struggling to find a house with an affordable monthly payment based on the current interest rates offered to you by your lender. It reduces the interest rate (either temporarily or permanently) and therefore reduces a monthly house payment.
- A buydown is most helpful when a seller offers it as a concession to a buyer — so there is no additional money coming out of pocket and the interest rate is still lower than market rate.
- It may not work for you if you don't have much cashflow and/or you don't plan on staying in the home long enough for the break-even point between the lower monthly payment and the upfront fee.
What Is a Buydown?
When lenders talk about a buydown, they're referencing the act of paying money in exchange for a lower interest rate. "Traditionally, this is achieved by buying points or a fraction thereof," explains Justin Brilman, mortgage loan officer at U.S. Bank. "For simplification, it is approximately one point in cost in exchange for a quarter percent lower interest rate," he continues. "One point is 1 percent of the loan, so on a $1,000,000 loan that is $10,000."
Fortunately, for most borrowers, those numbers are quite a bit lower. For example, if you have a $200,000 mortgage, it will only cost you $2,000 to lower your interest rate by .25 percent. A traditional buydown will reduce your interest rate on the life of the loan.
Are There Benefits to a Buydown?
Buying down your interest rate can get a bit expensive, especially for homebuyers who may be looking to cut costs wherever they can. This means it may not always be beneficial to do it — especially if you're struggling to come up with the funds you need for a down payment or if you're dipping into your emergency fund or other savings accounts.
"It is always important to calculate the monthly savings compared to the cost and how long it will take to realize the difference," explains Sarah Alvarez, vice president of mortgage banking at William Raveis Mortgage. "A temporary buydown, which has become very popular again, is a concession that temporarily reduces a buyer's rate on a conforming loan for either one or two years."
Alvarez says this can help keep the monthly mortgage payments low while you wait for the next cycle of lower rates and the opportunity to refinance. "If you're struggling to afford a monthly mortgage payment based on the current interest rates offered to you by your lender, you can ask about a buydown," she continues. "[If] the borrower chooses to buy down their rate, it is normally confirmed when locking the rate, and the cost is paid at closing."
What Is a Temporary Buydown?
With a temporary buydown, the seller must pay the cost, which is typically two points or 2 percent of the loan amount. "Using 7 percent as the example of the current mortgage rate, with a two to one, buydown would be 5 percent the first year and 6 percent the second year before returning to 7 percent for the remainder of the loan term," Alvarez says. "Using $750,000 as the purchase price and $600,000 as the loan amount, it is a savings of $18,000 for the borrower over the course of the two years: $12,000 the first year and $6,000 the second year."
Unlike a temporary buydown, a regular buydown will lower your interest rate for the life of your loan.
Should You Buy Down Your Interest Rate?
The break-even point between the lower monthly payment and the upfront fee is generally four years, according to Brilman. "When rates are nearing all-time lows, buying points on a loan you believe you will hold for a significant time period would be a good strategy," he says. "In market cycles where rates have been rising and expect to plateau and potentially come down in subsequent years (like we are now), we see much less of this activity due to those break-even periods." In short, a seller-paid temporary buydown may be your best bet, according to Brilman.
Alvarez says she is seeing a lot of sellers using the temporary buydown as a tool to attract buyers in this shifting market. It is more appealing than having to drop the sales price, and it feels like a win-win for everyone. It is also becoming more common for new developments to offer their own temporary buydown program, which can be designed to fit the needs of each building.
This concession allows for a significantly reduced payment your first two years. Brilman tells Hunker, "Since this is a seller-paid concession, the funds paid by the seller to allow for the buydown are placed in an escrow account and used to make up the difference from the temporary payment and the final payment. The reason this is relevant is if a borrower had the opportunity to refinance before year three, the savings benefit left in the initial two years is applied to pay down the loan balance, so the buyer never loses anything!"
Other Strategies to Make Buying a Home More Affordable
There are a few different ways to make buying a new home more affordable; it's not limited to purchasing a lower interest rate from your lender. "In a higher-rate market, it might make sense to look at paying off existing debts or making a larger deposit if you are capable, as the general understanding is that when the next lower rate cycle comes around, you can refinance and lock in a lower rate long term," Alvarez says. "In this case, an adjustable-rate mortgage with no points, which has a lower starting rate, might be a good fit."
Just remember that adjustable-rate mortgages can increase over time. If rates don't drop or if home values dip significantly, borrowers locked into adjustable-rate mortgages may find themselves faced with a higher monthly mortgage payment and little chance of relief if the market takes a negative turn.