A buydown is a type of financing where the buyer or seller pays extra points (also called discount points) to reduce the interest rate on a loan. Buydowns make it easier to qualify for a loan because they lower a loan's interest rate. They can also allow you to buy more house for your money.
There are generally two types of buydowns: a permanent buydown and a temporary buydown. A permanent buydown lets you pay extra points to get a low interest rate over the life of your loan. A temporary buydown lowers the rate on the loan for just the first few years.
Buydowns can be paid by the buyer or by the seller or builder (in new housing developments) as an incentive to finalize a sale by creating lower monthly payments. Sellers can also benefit from assisting with a buydown with a difficult to sell property or during slower market conditions. A buydown may increase the buyer's ability to qualify for a loan, thereby allowing the home to be sold more quickly. Plus, a buydown offer by a seller reduces the buyer's payments more than simply lowering the purchase price. It can be a win-win situation for the buyer and seller.
In a temporary buydown, you (or the seller or builder) prepay interest in exchange for a lower rate during the early years of a loan. The most common temporary buydown is called 3-2-1, meaning the mortgage payment in years one, two and three is calculated at rates 3 percent, 2 percent and 1 percent, respectively, below the rate on the loan. For example, if a 30 year fixed rate loan has a rate of 6.75% and you choose a 3-2-1 buydown, the rate in the first year will be 3.75%, the second year 4.75%, the third year 5.75%, and years 4 through 30 it will be fixed at 6.75%. This is a powerful tool and is increasing in popularity especially as sellers and builders offer incentives to move inventory.
A temporary buydown can be a benefit to a buyer whose current income is low but anticipates that it will increase during the next two years. First-time home buyers who need to purchase all of the furnishings that go into a new home may also find a temporary buydown appealing. In most cases, a lender will qualify the borrower based on the bought-down rate. This makes it easier to qualify for financing.
It is important when considering a buydown to weigh the costs and differences between a temporary and a permanent buydown. Our loan specialists are happy to help analyze your options so that you can make the best choice.