Over 82% of cash-out re-financers and almost 60% of non-cash-out re-financers chose to buy down their rate in 2023. Nearly 61% of borrowers with home loans paid discount points in September 2023, up from 31% in 2021.
Fannie Mae predicts mortgage rates to soar to 6.6% in 2024. This makes discount points a straightforward option for many homebuyers to be able to afford their new home. Buying down interest rates can help save thousands of dollars on mortgage payments.
We have also done some of the heavy lifting for you. With Houzeo’s list of mortgage lenders around you, finding one with terms suited to you has never been easier. Your home buying journey begins one click away, so don’t wait!
What Is a Mortgage Buydown?
A mortgage buydown is a financing arrangement that allows you to lower the interest rates on your mortgage by paying an upfront fee to the lender at closing.
This fee may range from 1% to 4% of the total loan amount. The rates may be lower temporarily for an initial period of 1 to 3 years, or permanently for the life of the loan. Sellers or builders offer this concession to decrease your monthly payments.
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How Much Does It Cost to Buy Down Interest Rates?
A mortgage buydown requires an upfront fee called a ‘point’. The cost of buying down interest rates depends on how many points you or the seller purchase. 1 point costs 1% of the total loan amount and reduces the interest rate by 0.25% or 0.5%, depending on your lender.
For example, a lender offers to lower the rates by 0.5% in exchange for a point. Then, on a $300,000 loan at 7% interest, paying 1 point ($3,000) will lower the rate to 6.5%.
How Can You Buy Down a Mortgage?
Buying down interest rates requires paying ‘mortgage points’. There are two types of mortgage points– ‘discount points’, and ‘purchase points’. Each point, irrespective of the type, costs 1% of the loan amount. However, each of these types of points works differently in lowering the interest rates:
1. Discount Points
Paying ‘discount points’ reduces the interest rate permanently for the life of the loan. This way of buying down interest rates is ideal only if you can afford a high upfront fee. Either you or the seller can purchase discount points.
Sellers may offer to do this to make the mortgage cheaper for you and to close the deal on a home. However, this concession comes at a price. The seller will hike the price of the home to recover his expenses on the buydown.
2. Purchase Points
Paying ‘purchase points’ upfront reduces the interest rate temporarily only for a few years at the beginning of the loan. Either you or the seller can pay purchase points. This way, you can save money since the mortgage payments will be lower.
How Long Does It Take to Recover Buydown Costs?
The time it will take you to recover the cost of a buydown is determined by calculating the break-even point:
Break-even point = Total cost of discount points / monthly savings
For example, if you take a loan of $400,000 at 6.75% interest, paying $4000 will reduce the interest rate to 6.25%. Your monthly savings would look like this:
| Points purchased | Interest rate (%) | Monthly payments | Monthly savings |
| 1 | 6.25% | $2,771 | $132 |
| 0 | 6.75% | $2,903 | $0 |
So, the break-even point here can be calculated as $4000 / $132 = 30 months, which is approximately 2.5 years. This means it will take you 2.5 years to recover the cost of the buydown.
How Are Mortgage Buydowns Structured?
Mortgage buydowns can be temporary or permanent, depending on the type of points purchased.
Permanent Buydown
You or the seller pay discount points to permanently reduce the interest rate for the full loan term. This helps you save more in the long run but requires a larger upfront cost. The average life of a loan is 6 to 7 years
Temporary Buydown
You or the seller pay purchase points to temporarily reduce the rate for a few years at the start of the mortgage. This type of buydown is ideal to lower your mortgage payments until you attain a higher income.
Temporary buydowns have different structures depending on the number of years the buydown period lasts:
1-0 Buydown
This is a temporary type of mortgage buydown. In this case, the interest rate is 1% lower only for the first year of the loan term. After this, the mortgage rate increases to the standard rate.
For example, a 1-0 buydown on a 30-year fixed home loan, where you have borrowed $300,000 at an interest rate of 7%, will look like this:
| Year | Interest rate (%) | Monthly Payments | Monthly savings | Annual savings |
| 1 | 6 | $1798.65 | $196.76 | $2361.12 |
| 2-30 | 7 | $1995.41 | $0 | $0 |
Hence, in this type of mortgage buydown, you can save on monthly payments only in the first year of the loan.
2-1 Buydown
This is a temporary mortgage buydown. The points you purchase will lower the interest rate only for the first two years of the loan term. The rate is 2% lower in the first year, and in the second year, the rate is 1% lower. After that, the rates increase to the contract rates.
Taking the previous example of a fixed loan of $300,000 at a 7% interest rate, your monthly savings will look like this:
| Year | Interest rate (%) | Monthly Payments | Monthly savings | Annual savings |
| 1 | 5 | $1610.46 | $384.95 | $4619.40 |
| 2 | 6 | $1798.65 | $196.76 | $2361.12 |
| 3 – 30 | 7 | $1995.41 | $0 | $0 |
3-2-1 Buydown
This is a temporary mortgage buydown. The interest rates are 3% lower in the first year, 2% lower in the second year, and 1% lower in the third year of the loan period. After this, they increase to match the standard interest rates.
Using the same example as before, the buydown structure will be as follows:
| Year | Interest rate (%) | Monthly payments | Monthly savings | Annual savings |
| 1 | 4 | $1,432.25 | $563.16 | $6757.92 |
| 2 | 5 | $1610.46 | $384.95 | $4619.40 |
| 3 | 6 | $1798.65 | $196.76 | $2361.12 |
| 4 – 30 | 7 | $1995.41 | $0 | $0 |
Should You Buy Down Mortgage Rates?
Buying down interest rates on a home loan may be a good option for you, depending on various factors. These factors are explained below.
Who Pays the Discount Points?
If the seller or builder of the home you want to purchase offers to contribute towards the buydown, it may be a good option as you don’t have to worry about paying anything upfront.
A seller may offer to pay for the buydown in order to incentivize you to buy the home. The points they may purchase will be counted as ‘seller concessions’.
Can You Afford a Buydown?
A buydown may be expensive after paying down payments and closing costs on a mortgage. Each point paid towards a buydown costs 1% of the total home loan and usually lowers the rate by 0.25% – 0.50%.
Hence, if you take a loan of $400,000, lowering the interest rate by 1% can cost between 2 and 4 points. As each point costs 1% of the total loan amount, the final cost may lie between $8000 and $16,000.
However, to get an estimate you must use a mortgage calculator. It will help you determine your monthly payments. This will give you a clear picture of how much you need to buydown.
Do You Expect a Higher Income?
A temporary buydown can lower your monthly payments until you attain a higher income. For example, if you are getting a promotion at work or a professional degree that will pay you well, a temporary buydown will help you save until the buydown period lasts.
How Long Do You Plan to Stay?
A permanent buydown may be a good option if you plan to stay in the home for a longer period of time, as it will give you better savings. It may be a bad option to sell or refinance the home before you recover the expenses of the buydown.
For example, if you buy down the interest rates on a mortgage by paying $4000 and your monthly savings are $132, it will take you 2.5 years to recover the $4000 you paid for the buydown. Hence, it will not make sense to sell the home before the 2.5 year mark.
Does the Buydown Have a Limit?
Yes, there are limits to how much you can buy down on mortgages. The limits vary with the lender, type of loan, and your credit scores. Have a look below:
- Lender Restrictions
Lenders restrict the number of discount points purchased to up to 4 points per loan. They may also not allow you to lower the interest rates by more than 3%.
- Adjustable-Rate Mortgages
On adjustable-rate mortgages (ARM), temporary buydowns are permitted only on those plans with an initial interest rate period of at least 3 years. Additionally, it needs to follow a 2-1 buydown structure where the buydown period is no longer than 24 months.
- Seller Limits
There are limits on how much a seller can contribute towards closing costs.
Fannie Mae and Freddie Mac loans have varying limits for the down payment size:
- For less than 10% down payment, the limit is up to 3% of the purchase price of the home.
- Down payments between 10 to 24.99% carry a limit of up to 6% of the purchase price.
- For down payments more than 25%, the limit is up to 9% of the purchase price.
FHA and USDA loans limit it to up to 6% of the total loan amount. For VA loans, the limit is up to 4%.
- Credit Score Requirements
For certain loans, a minimum credit score is required to qualify for a buydown. For a 2-1 buydown, FHA and VA loans require a minimum credit score of 580. Conventional loans may require a minimum credit score of 620.
Bottom Line
A mortgage buydown can help you save money in the long run if you are looking to buy your dream home. Make sure to calculate the break-even point to understand whether you will be able to recover the money you invest in a buydown.
If you are new to home-owning and borrowing, Houzeo has got you covered. As one of the largest real estate transaction platforms in the US, we have curated a list of verified lenders around you. Shop around to find a lender with suitable terms and begin your home-buying journey now.
Frequently Asked Questions
How to buy down interest rates?
There are two ways to buy down interest rates, depending on the kind of mortgage points you purchase. ‘Discount points’ can lower your interest rates for the entire loan term. ‘Purchase points’, can lower interest rates for an initial period of 1 to 3 years, after which the rates will rebound.
What is a 2-1 buydown?
A 2-1 buydown is a temporary buydown structure where the interest rates are low for the first two years of the mortgage. The rates are 2% lower in the first year, and 1% lower in the second, than the original rates. From the third year onwards, they increase to match the original.
How much does it cost to buy down interest rates?
The cost to buy down interest rates may vary between lenders. It needs an upfront payment called ‘points’. Each point costs 1% of the total mortgage amount. Paying 1 point can lower the interest rate by 0.25%, or sometimes 0.5%. So, if you take a loan of $300,000 at an interest rate of 7%, you can pay $3000 to lower the rate to 6.5%.
