If you’re in the market to buy a new home, rising mortgage interest rates may make it more difficult for you to get an affordable mortgage. However, to combat these rates and help buyers secure a home with a payment that is within their budget, many lenders are leveraging a mortgage product known as a temporary mortgage rate buydown. This allows you to pay extra for a lower interest rate, rolling that cost into the mortgage.
A temporary mortgage buydown can be a great way to reduce costs and contend with higher interest rates. Could this be the right option for you?
In this blog, we will explain all about temporary mortgage rate buydowns and how they might be the answer you’re looking for if you want to buy a home now.
Some Highlights
- A temporary buydown permits homebuyers to obtain a lower interest rate when taking out a mortgage loan.
- Buydowns can save homeowners money on interest over the life of the loan.
- A buydown can involve purchasing discount points against the mortgage loan, which may require payment of an up-front fee.
- Whether it makes sense to choose a buydown when buying a home can depend on the interest rate you qualify for and how long you plan to remain in the home.
What is a Temporary Mortgage Buydown?
A Temporary Mortgage Buydown is a financing instrument that permits well-qualified borrowers to reduce their monthly payments during the early years of their mortgage. The mortgage payments and interest rates are decreased in the beginning years due to a lump sum of money deposited into a buydown account.
The buydown funds are used to reduce the borrower’s payments each month. Then, the borrower’s rate and costs rise yearly until the total monthly payment amount arrives by the end of the buydown period. The borrower may acquire the buydown money from various sources, such as the lender, property seller, or other interested parties.
A mortgage rate buydown can be arranged in a number of ways, and the terms are negotiable from lender to lender. Regardless of which lender you work with, the fee of the buydown mortgage rate is paid at your closing.
The cost of the buydown can be paid by either the seller or the Home Buyer. The payment may be in the form of mortgage points or a lump sum deposited in an escrow account with the lender and used to fund the borrower’s lowered monthly payments. Either way, an upfront cash deposit is required and is what offsets the discounted interest rate.
More Temporary Mortgage Buydown Details
A temporary buydown lets borrowers reduce their effective monthly payment for a limited time through a temporary buydown of the interest rate while still providing the stability of a fixed rate mortgage. It is important to note that the lender’s interest rate isn’t actually lowered.
In this type of buydown, the effective interest rate that a borrower pays during the early years of the mortgage is reduced as a result of the deposit of a lump sum of money into a buydown account, a portion of which is released each month to reduce the borrower’s payments. The buydown funds may be provided by various parties, including the borrower, the lender, the borrower’s employer, the property seller, or other interested parties to the transaction. Fannie Mae has a selling guide that details the allowable sources of temporary buydown funds.
The 2/1 Mortgage Buydown
The 2/1 Buydown is the most commonplace type of temporary mortgage buydown. It is a mortgage agreement that provides for a low interest rate for the first year of the loan, a somewhat higher rate for the second year, and then the total rate for the third and later years. A 2/1 temporary buydown is allowed on Conventional, FHA, VA, and USDA mortgages. It is a temporary 2% rate reduction below the note rate during the first year of the mortgage and a 1% reduction during the second year of the loan. In the third year of the mortgage, the interest rate returns to the total note rate for the remaining term of the loan. The rate changes automatically, and the borrower is not required to requalify for their loan.
What Type of Home Buyer Can Benefit Most
While a temporary mortgage buydown isn’t ideal for everyone, certain types of home buyers should give serious thought to availing themselves of a buydown as a way to make buying a home more affordable.
Anticipate your household income rising in the next couple of years due to promotions or raises, or your spouse is planning to return to work in the next or so. A temporary buydown could be an excellent option for you. This is also a good alternative if you need extra funds to be available for an expected life change, such as having a baby and will be ready for the future rate increase.
Positives and Negatives of Buying Down Your Interest Rate
As with every loan type you will look at on your home buying journey, there are positives and negatives to be aware of when buying down your mortgage rate. Here are some of each to contemplate as you’re trying to decide whether this is the way to go when buying your new home.
Positives:
- You’ll save money on your monthly payment
- You’ll pay less interest over the life of your loan
- You may be able to write off the buydown mortgage costs on your taxes
- You’ll qualify for a higher loan amount because your interest rate is lower
Negatives:
- Your total closing costs will be higher
- Your interest rate and monthly payment could increase
- You could lose your home to foreclosure if you didn’t make the higher payment
- You’ll deplete cash savings to cover the buydown mortgage expense
How to Pay For a Mortgage Buydown
When it comes to paying for a mortgage rate buydown, there are several options. You can cover the cost yourself, you can ask the seller to pay for it, or finance it into your loan. Here’s how each alternative works:
Pay cash – If you have extra money available, you can use it to pay for a lower rate.
Ask the seller to pay – Some sellers, especially if interest rates continue to rise, may try to incentivize you to buy their home by offering to pay for a rate buydown.
Gift funds – If you’re receiving a gift from family or a close friend, you may be able to apply the gift funds to a mortgage rate buydown.
In Conclusion
The goal of the Spectrum Real Estate Consultants Team is to help home buyers achieve their dream of home ownership. Depending on your situation, a temporary mortgage buydown could be just what you need to get into your new home.
We are the top producing team of Realtors at Keller Williams Realty Leading Edge, completing over 900+ successful transactions since 2015. Our mission is to provide our clients with world-class service while simplifying the Real Estate transaction through experience, technology, and effective communication. And we have built a referral network of trusted mortgage professionals that we know can take care of your mortgage needs with integrity, and we are happy to refer you to them. So, let’s connect and get you on the road to owning your dream house today.