Unlocking Affordability: Understanding the Mortgage Rate Buydown

What is a buydown on a mortgage?

A mortgage buydown involves your home seller, developer, or real estate agent paying the mortgage lender to reduce your mortgage rate for the first one, two or three years of your home loan. After that, your provisional rate reverts to the original one.

That’s called a temporary mortgage buydown. A permanent mortgage buydown involves you buying yourself — or someone else buying you — discount points. Each discount point reduces your mortgage rate throughout the entire life of the loan. Read on as we dig into how each of these work.

In this article (Skip to...)

• How do rate buydowns work?
• Mortgage rate buydown vs points
• Types of mortgage rate buydowns
• When does a rate buydown make sense?
• The bottom line

How do mortgage rate buydowns work?

Many home sellers are lovely people. You’ll probably be one yourself one day.

But few are lovely enough to want to give money away to their home buyers. So, a mortgage buydown is strictly business.

A motivated seller — an individual or a developer — might counter your below-asking-price new home offer with a different deal that includes a mortgage buydown. You have to ask yourself whether the package that makes up that counteroffer is attractive enough for you to go ahead with the home purchase.

If you’re using a good buyers’ agent, he or she should walk you through the deal, showing how the interest rate buydown will affect your monthly mortgage payments and your total cost of borrowing. And you or your real estate agent may be able to negotiate a better counter-counteroffer.

Occasionally, real estate agents might even chip in with some of their commission to close deals that involve buydowns. Just as for the seller, a bird in the agent’s hand is worth two in the bush.

How does a buydown work? Typically, the seller or agent lodges into an escrow account the difference between the mortgage interest you would have paid at your full interest rate and the discounted one you actually will pay. And the lender accesses that money as required to keep your mortgage account current.

How mortgage buydowns affect your mortgage rate

We already mentioned that mortgage buydowns typically last for one, two or three years of the loan. It’s up to you and the seller to negotiate the period for which the arrangement lasts and the size of the rate discount you receive.

How valuable your mortgage buydown will be will depend on how motivated or desperate the seller is to dispose of the home. Many see their mortgage interest rate reduced by 1% (100 basis points) just during the loan’s first year. It’s much less common, though far from unknown, for a buyer to see a 3% reduction in year one, 2% in year two, and 1% in year three.

Examples

On the day this was written, the average interest rate for a conventional, 30-year, fixed-rate mortgage (FRM) was 6.95%. That was high by 21st-century standards. And we hope it will lower by the time you read this. But it might not be. So, check out where mortgage rates today stand.

If you negotiate a 1% rate reduction for your first year, that would give you a mortgage rate of 5.96% for those 12 months. Let’s use The Mortgage Reports’ mortgage calculator to work out what that means in dollars and cents.

According to the National Association of Realtors®, the median home price in October 2023 was $391,800. So, we’ll base our calculation on that and assume you’re choosing a conventional, 30-year FRM with a 20% down payment.

Don’t worry if that’s a million miles away from your scenario. You can input your own figures to model your particular circumstances.

Remember, your mortgage rate will revert to the one you signed up for once a mortgage buydown expires.

And your lender won’t approve your application based on the discounted rate. You must qualify for the full rate to get your mortgage.

Example 1

So, in our 1%-discount-for-one-year example, you’d pay a 5.95% mortgage rate instead of the original rate of 6.95% for the first 12 months. That would mean a monthly payment (principal and interest) of $1,869 based on our assumptions. And that compares with a monthly payment of $2,075 at 6.95%.

So, you’d save $206 a month, which is a $2,472 saving over that first year. For many home buyers, who tend to be stretched financially just after they’ve moved, that’s a welcome saving.

Example 2

But what about that other scenario we described? The one in which you get a 3% reduction in year one, 2% in year two, and 1% in year three. How would that play out?

Well, based on our earlier assumptions, in year one, your mortgage rate would be 3.95%. And you’d have a monthly payment of $1,487 instead of $2,075 for those first 12 months. In the following year, you’d have a 4.95% rate and your lower payments would be $ 1,673. And in your third and last year, your rate would be 5.95% and your lower payments would be $1,869.

So, your total savings in each year would be:

• $7,056 in the first year ($2,075 monthly payment at 6.95% - $1,487 payment at 3.95% = $588 monthly saving x 12 = $7,056 saving for year one)
• $4,824 in the second year ($2,075 - $1,673 = $402 monthly x 12 = $4,824 saving over year two)
• $2,472 in the third year ($2,075 - $1,869 = $206 monthly x 12 = $2,472 saving over the third year)

Add up those savings each year and they total $14,352. You can see why such three-year deals are relatively rare. You’d need to find a desperate seller to swing that one. But it happens.

How is a mortgage buydown different from paying points?

Mortgage professionals disagree over whether or not buying discount points on closing is a form of mortgage buydown. But you should know the differences between the two. So far, we’ve talked about temporary mortgage buydowns. So, it’s time to explore permanent ones.

Mortgage lenders allow borrowers to buy discount points on closing. Each discount point costs 1% of the loan’s value. And it typically buys you a 0.25% (25-basis-point) reduction in your mortgage rate.

With an FRM, that reduction lasts for the entire mortgage loan term, up to 30 years. Naturally, the longer your mortgage continues, the bigger the value you’ll derive. And, if you plan to move or refinance in a relatively short period of time (say, four to 10 years), you should run the numbers to see if mortgage points are worth it for you.

Most readers probably missed the “typically” in the earlier sentence that said a discount point typically buys you a 0.25% (25-basis-point) reduction. But that word was doing a lot of heavy lifting.

The value of a discount point can go up and down with markets. For example, in August 2023, Mortgage News Daily reported, “A discount point (1% of the loan balance) is still good for at least a 0.375% reduction in rate at most lenders.”

That’s a much better deal than 0.25%. So, get a quote from your lender for what a discount point is worth when you’re borrowing.

What are the different types of mortgage buydowns?

Mortgage lenders are used to dealing with temporary buydowns. And they’re generally happy working with a variety of buydown options. It’s really up to you to reach the best arrangement with the seller or your agent.

A 3-2-1 buydown is a common type of buydown you might be offered:

• 1-0 — A 1% reduction in year one (our first example, above)
• 2-1 — A 2% reduction in year one tapering down to a 1% reduction in year two
• 3-2-1 — A 3% reduction in year one, tapering down to a 2% reduction in year two, and finally a 1% reduction in year three (our other example, above)

Those numerals are sometimes written with slashes instead of dashes: 1/0, 2/1 and 3/2/1.

When does a mortgage buydown make sense?

A great thing about a mortgage buydown is that it’s all about the math. You can measure in dollars and cents the impact a particular rate reduction will have in each year one applies.

And you can then compare those savings with ones you would make with a lower purchase price and its resulting smaller loan and lower monthly payment.

Chances are, you’ll save more in the early years of owning the home with the buydown. But you’ll save more over 30 years with a lower price and smaller loan. But run the figures because that may not always be the case.

Once you’ve established the figures ask yourself two questions. First, how long will you likely live in the home with the same mortgage? The sooner you move or refinance, the more attractive a temporary mortgage buydown is. (But, conversely, the less attractive discount points are.)

Secondly, ask yourself how financially comfortable the early years of your time in your next home will be. If you’ve stretched yourself, and those years are likely to be challenging, it’s fine to make them easier by taking the mortgage rate buydown.

That can apply even if the numbers say a lower price is the smarter move. In practical terms, money can be worth more to you in difficult times than easy ones.

Discount points

With discount points, you can work out your breakeven point. You simply divide the cost of the points by the monthly savings. And you’ll reveal after how many months your investment will have paid for itself. Ask yourself three questions:

1. For how long after the breakeven point will you have the same mortgage? If it’s not long, the points may not be worth it
2. How easily can you afford to buy the points? Only you can judge whether any financial sacrifice is worth the interest savings
3. How good a deal are you being offered? Markets determine how big a rate discount a point can buy you. But you can negotiate with your lender around the edges

Like temporary mortgage buydowns, discount points are fundamentally math. But you still need to make judgments once you know the figures.

Conclusion

Temporary mortgage buydowns can genuinely make the early years in your home financially easier. But you need to find a highly motivated seller to get the most significant savings.

Those buydowns usually arise as a trade-off within a counteroffer. The seller hopes you’ll go with a smaller or zero price reduction in exchange for a lower interest rate over your first one, two or three years in the home.

You can easily run the numbers. But only you can decide how attractive those are in your personal finances. You or your buyers’ agent should negotiate the best possible deal overall.

Such buydowns can be especially attractive if you plan to move or remortgage relatively soon. You’ll enjoy a lower mortgage rate for a bigger proportion of your home loan’s eventual term.

Always be open to proposals about mortgage buydowns. But don’t automatically accept one. Negotiate to get yourself the best advantage over the long and short terms. And don’t forget that discount points are sometimes very attractive if you can comfortably afford them.