Buydown to Reduce Your Mortgage Interest Rate

If you are buying a home, you have probably looked at all kinds of ways to reduce your monthly mortgage costs. These can include putting down a higher down payment or improving your credit to get a lower interest rate. But did you know that you can actually pay to lower your interest rate by doing a buydown?

Buying down points on your mortgage is when you, the buyer, pays a fee to lower the interest rate of your loan. This fee is paid upfront, with each point purchased costing 1% of the overall loan amount. Let’s look at an example.

Sally wants to purchase a home for $500,000 with a down payment of $100,000 and her lender offers her a 30-year fixed loan with a 3.75% interest rate. Sally wants a better interest rate, resulting in greater savings, especially in the first few years that she is paying the mortgage because the interest is paid up front. The lender says that she can purchase one point for 1% of the loan amount, $4,000 for the $400,000 that Sally plans to borrow, and it will reduce her interest rate by 0.25%. Sally is happy that she will get an interest rate of 3.5%.

Buyers often want mortgage points, and sellers sometimes offer them to make the purchase more appealing. This happens more often in a buyer’s market when the seller makes extra concessions to sell their home. Builders can also use the same strategy to sell new homes.

What is a 3-2-1 buydown?

With a 3-2-1 buydown, the interest rate drops for the first three years and increases incrementally until reaching the original rate in Year 4. If it is reduced by 0.25% increments, the first year it will be 0.75% lower, the second year it will be 0.5% lower, and the third year it will be 0.25% lower. A similar strategy can be used with a 2-1 buydown as well.

What is an Interest Rate Reduction?

An interest rate reduction occurs when the lower interest rate applies to the entire loan duration. Reducing the interest rate often costs more, but the savings can be significant if much time remains on the loan.

When should you buy points?

To determine if buying mortgage points to reduce your interest rate is the best option for you. Consider how long it will take you to recoup the upfront costs. You can divide the cost of the points by the monthly savings to determine your breakeven point. The amount of time it will take you to recoup that expense. If you plan to sell the home before that point, it is probably not the best idea to buy points. If you have to chose between the down payment and buying points, contributing more to your down payment is usually the better choice.

There may be situations where you cannot buy down points, such as an investment property or during a cash-out refinance. Talk to your lender about what options are available for you.