How do you buy down your interest rate?
The figures in this article are provided solely for educational purposes. Consult with a lender for specific terms.
Quick insights
- Mortgage rate buydowns let buyers or sellers pay upfront to reduce interest rates and monthly payments.
- Permanent buydowns use discount points for lifetime savings, while temporary buydowns offer short-term reductions.
- The benefits and costs of buying down your rate depend on the upfront payments, loan duration and whether the buydown is permanent or temporary.
For homebuyers, mortgage interest rates can significantly affect monthly budgets and long-term borrowing costs. One way to lower your mortgage interest rate is by making an upfront payment to secure a rate reduction.
What is a buydown on a mortgage?
An interest rate buydown occurs when a homebuyer or another party, like a seller or developer, negotiates with the lender to pay an upfront fee to lower their interest rate. This usually takes one of two forms: a permanent buydown using mortgage discount points, which is paid by the buyer, or a temporary buydown, which is paid by the seller or another third party.
Permanent buydown?
A permanent buydown allows homebuyers to purchase mortgage discount points to reduce their interest rate for the life of the loan. They do this by buying points, which are usually equal to 1% of the value of the loan. Each point could lower the interest rate by 0.25%, but the exact amount will depend on your lender.
When you buy mortgage points, you’ll generally need to pay up front, but you can potentially save more money in the long run.
Temporary buydown?
Another way to buy down an interest rate is a temporary interest rate buydown. This can be done by a borrower, but it may also be used by sellers or builders as an enticement for homebuyers.
With a temporary buydown, the seller helps finance the buyer’s mortgage by paying the difference in cost of the interest rate for the first one to three yearsOpens overlay. The buyer gets the temporary benefit of a lower interest rate, and the lender still receives the full monthly payment at the original interest rate. The buyer may receive a lower initial payment without paying the buydown fee directly, but the overall economics of the deal can vary (through the negotiated home price or other concessions, for example).
How does a mortgage buydown work?
A mortgage discount point typically costs 1% of the loan amount and may reduce the interest rate by about 0.25%, depending on the lender. When you “buy down” an interest rate, you’re basically prepaying interest on your loan. You pay a lump sum at closing, and in exchange, the lender reduces your interest rate for a defined term. This lowers your monthly principal-and-interest payment during that window.
In many temporary buydowns, the note (contract) interest rate may remain the same, but a temporary subsidy reduces your monthly payment for a limited time. After the buydown ends, your payment increases to the payment based on the note rate shown in your loan documents.
Who can buy down a mortgage rate?
Several parties can fund a mortgage rate buydown, and the source of the money shapes the value you receive:
- Borrower (you): You pay upfront at closing, trading cash for lower payments during the buydown period. Consider comparing this against using the same cash for a larger down payment or permanent discount points.
- Seller: They may fund the buydown as a concession to attract buyers, often costing them less than reducing the price of the home. This type of buydown is subject to concession limits based on loan type.
- Builder: A buydown may be offered as a new-construction incentive but offset elsewhere in the sale, such as the purchase price.
- Lender: You may be able to finance the buydown instead of paying a lump sum up front. The lender may give you a slightly higher contract rate for the life of your loan in exchange for a credit covering the buydown. You avoid an upfront cost but pay that amount long-term.
- Employer relocation programs: Some employers fund buydowns as part of a relocation package to ease housing costs during a transfer.
How much does it cost to buy down an interest rate?
The cost to buy down the interest rate for a mortgage loan will depend on whether you’re using a permanent buydown or a temporary buydown.
For a permanent buydown, if you had a $400,000 loan, you would pay 1% of the loan value or $4,000 per point. While you need to pay upfront for points, they can provide real savings over the life of your loan. Assuming a $400,000 mortgage with a 30-year term and fixed rate of 6%, your monthly payment would be approximately $2,398.
Here’s how much each point you bought down would affect your monthly mortgage payment (approximately):
- 1 point: Cost $4,000. New interest rate of 5.75%. New monthly payment is $2,334.
- 2 points: Cost $8,000. New interest rate of 5.5%. New monthly payment is $2,271.
- 3 points: Cost $12,000. New interest rate of 5.25%. New monthly payment is $2,209.
- 4 points: Cost $16,000. New interest rate of 5%. New monthly payment is $2,147.
Your total savings will depend on how long you keep the mortgage. Using the example above, if you were to buy two points for $8,000, you’d save about $127 a month. If you divide your monthly savings by the amount you paid for points, you’ll reach your break-even point after 63 months. After that, you could save about $1,524 per year on your mortgage. The longer you keep your current mortgage, the more you’re likely to save.
How are buydowns structured?
For home sellers, temporary interest rate buydowns are usually structured over a one- to three-year period and cost the difference between the reduced and original payment. Different types are usually represented as follows:
- 1-0 buydown
- 1-1 buydown
- 2-1 buydown
- 3-2-1 buydown
The numbers indicate how much the interest is reduced from the key interest rate for each year of the loan.
For the following examples, let’s again assume you’re borrowing $400,000 at a 6% interest rate. In each case, the amount you’d save would need to be prepaid by the seller at closing.
1-0 interest rate buydown
A 1-0 buydown signifies that there is a 1% interest rate reduction for the first year. So, for the first year, you’d have a 5% interest rate and a lower monthly payment of $2,145. After that, you’d go back to a 6% interest rate and a monthly payment of $2,398.
Total savings: For the first year, you’d save $253 each month on your mortgage payments and $3,036 in total.
1-1 interest rate buydown
This type of buydown comes with a 1% interest rate reduction for the first two years. So, for both of those years, you’d pay a 5% interest rate and have a monthly payment of $2,145. Starting in year 3, you’d go back to the 6% interest rate and the $2,398 monthly payment.
Total savings: For the first two years, you’d save $253 each month on your mortgage payments and $6,072 in total.
2-1 interest rate buydown
A 2-1 buydown means the buyer receives a 2% reduction for the first year and a 1% reduction for the second year. In this example, you’d only pay 4% interest the first year and have a monthly payment of $1,908. The second year you’d pay 5% and have a monthly payment of $2,145. After that, you’d return to the original 6% interest rate and a monthly payment of $2,398.
Total savings: For the first year, you’d save $490 each month and in the second year, you’d save $253 each month. You’d save $8,916 in total.
3-2-1 interest rate buydown
A 3-2-1 buydown translates to a 3% reduction for the first year, a 2% reduction for the second year and a 1% reduction for the third year. In this example, your buydown would work as follows:
- Year 1: 3% interest rate and a $1,685 monthly payment
- Year 2: 4% interest rate and a $1,908 monthly payment
- Year 3: 5% interest rate and a $2,145 monthly payment
- Years 4–30: 6% interest rate and a $2,398 monthly payment
Total savings: For the first year, you’d save $713 each month. For the second year, you’d save $490 each month and the third year you’d save $253 each month. In total, you’d save $17,472.
Pros and cons of mortgage interest buydowns
There are benefits to buying down your mortgage interest as a homebuyer or receiving a temporary buydown from a home seller, but it can be helpful to weigh the pros and cons before you commit to a buydown.
Pros of a mortgage interest buydown
- Lower mortgage payments: If you’re able to benefit from a mortgage interest buydown, you’ll have a lower monthly mortgage payment, even if you buy the points yourself.
- More cash available: If someone else is paying for a temporary interest buydown, you can hold onto the extra cash or apply it toward your mortgage principal. If you pay for the points, the lower monthly payments could lead to a less strict monthly budget.
- Possible tax deduction: If you purchase points for a permanent buydown, you may be able to deduct themOpens overlay on your income tax return. However, it may be worthwhile to talk with a tax professional beforehand to better understand the implications of doing so.
Cons of a mortgage interest buydown
- Higher payments later: While your payments may be lower for the first few years with a temporary buydown, they will go up over time. If you don’t have the income to cover those payments, you may risk defaulting on your mortgage.
- Loss on investment: If you sell or refinance your mortgage before you reach your break-even point, you could wind up losing more than you’d gain.
- Different tax treatment for investment properties: Points paid on a primary residence may be deductible in the year you pay them if you meet certain IRS requirements. Points on an investment or rental property are treated differently. They generally must be amortized (deducted gradually) over the life of the loan. If you have additional questions related to potential tax implications, it may be worthwhile to seek out the advice of a tax professional.
Should you buy down your mortgage rate?
A buydown can be a strong strategy when:
- You expect your income to rise before the note rate takes effect.
- You plan to sell or refinance before the buydown period ends.
- A seller or builder is willing to fund it, so you capture the benefit without paying out of pocket.
- Current rates are high and you want to ease into the payment.
Several considerations deserve attention:
- The savings are temporary. Once the buydown expires, your payment changes (usually an increase). It can be beneficial to know if you can afford the higher payment long-term.
- Qualifying at the contract rate. Some lenders qualify you at the loan contract rate rather than the reduced buydown rate. Other lenders, particularly on certain loan types, may allow qualification at the buydown rate. Knowing which applies to your loan and when can help you anticipate costs.
- Compare against a rate discount. Sometimes negotiating a lower permanent rate or a seller credit toward closing costs delivers better long-term value than a temporary buydown.
- Refinancing plans. Your mortgage loan contract rate can be helpful to plan for. That will affect your monthly payment and budget over the long term unless you refinance.
- Break-even point. The break-even point can be a useful tool when deciding whether paying for discount points aligns with your long-term homeownership plans.
In short, a mortgage buydown trades an upfront payment for short-term payment relief. Whether it benefits you depends on who funds it, how long you intend to hold the loan and how the buydown cost compares to the alternatives available to you.
In summary
Buying down interest rates can be a valuable way for homebuyers to pay less on their mortgage interest over the life of the loan. It can also serve as a helpful incentive for sellers to encourage more potential buyers.
Whether you choose to buy points or offer a temporary buydown will ultimately depend on how much you can afford to put down. It’s also helpful to talk to your lender to see if the benefits of a buydown outweigh the upfront costs.
Interest rate buydown: FAQs
Is it smart to buy down interest rates?
Buying mortgage discount points usually makes the most sense when market interest rates are high or if you plan to keep the mortgage for a long time. Depending on your savings, it may be better to put money toward a larger down payment. Reaching 20% down can help you avoid private mortgage insurance (PMI), which may save you more than buying points would.
How much does 1 point buy down an interest rate?
For a permanent buydown, a point usually costs 1% of the value of the loan or $1,000 per every $100,000 borrowed. This usually lowers the interest rate by 0.25% per point. Some lenders may allow borrowers to buy half-points, which would lower the interest rate by 0.125%.
Are there alternatives to an interest rate buydown?
If you’re concerned about how interest rates could affect your monthly budget, you could ask your lender about an adjustable-rate mortgage (ARM). You would get a lower interest rate for the first several years of the mortgage, but the rate would adjust annually after that depending on current interest rates.
If you plan on moving or selling your home before the introductory period ends, this could be a better option than buying down the interest rate on a fixed-rate mortgage.
