When you decide to buy a house, you’re not only committing to paying for the purchase price of the home but also the interest rate on your mortgage loan – the cost of borrowing money from your mortgage lender.
While interest rates have fallen in recent months, many homebuyers are still seeking ways to make homebuying more affordable. And while it may be tempting to sit tight and hope that mortgage rates continue to drop, that’s not guaranteed to happen. That’s where mortgage rate buydowns come into play.
By paying a bit more upfront, you can ensure a lower mortgage rate and keep more money in your pocket each month.
What is a mortgage buydown?
A “mortgage buydown” is a financing agreement where the buyer, seller, or builder pays mortgage points, also known as discount points, at closing to obtain a lower interest rate. This one-time fee is paid at closing in exchange for a lower interest rate.
There are many ways to buy down a mortgage, depending on your lender and whether you want a permanent or temporary mortgage buydown rate.
Permanent vs. temporary buydowns
A mortgage buydown can take place over a set period of time or the duration of the loan.
Permanent mortgage buydown
With this option, you’ll buy a lower rate for the entirety of the loan term at closing from your lender through discount points. Unlike a temporary mortgage buydown, the rate will never increase.
Temporary mortgage buydown
With this arrangement, your mortgage interest rates will be reduced for a period of time before returning to the standard amount. You’ll see structures of temporary mortgage buydowns referred to as a “3-2-1 buydown” or a “2-1 buydown,” for example. We’ll cover what each arrangement looks like later.
How much does a mortgage buydown cost?
Each mortgage point a borrower pays usually equals 1% of the loan amount and typically reduces your interest rate by 0.25%. For example, one point would lower the mortgage rate from 6% to 5.75%. However, the amount each discount point lowers the rate can vary between lenders.
Mortgage buydown example
Let’s say a mortgage lender offers you, the borrower, the ability to reduce the interest rate by 0.25% in exchange for buying one point. So, if your loan amount is $500,000 and the interest rate is 6%, the borrower is able to lower their interest rate to 5.75% with one discount point by paying $5,000 (1% of $500,000) upfront.
When should you consider buying down your mortgage?
A mortgage buydown can be a smart strategy if your goal is to lower your monthly payment, especially in a high-rate environment. But it’s not right for every buyer. Whether a buydown makes sense depends on who’s paying for it, how long you plan to stay in the home, and whether you want short-term or long-term payment relief.
A mortgage buydown makes the most sense if:
A seller or builder is paying for it.
This is the most attractive scenario for buyers. In a buyer’s market, sellers and homebuilders often offer rate buydowns as a concession to help move inventory. Since you get the benefit of a lower interest rate without paying the cost yourself, this is usually a win.
You want a lower payment in the first few years.
Many buyers use temporary buydowns, such as a 2-1 or 3-2-1 buydown, to ease into homeownership. This can be helpful if your income is expected to increase, you’re adjusting to new housing expenses, or you want extra cash flow for moving and home improvements.
You plan to stay in the home long enough to justify the upfront cost.
If you’re paying for the buydown yourself, it generally only makes sense if you plan to stay in the home long enough for your monthly savings to offset the cost of the discount points.
You’re buying when interest rates are relatively high.
Buydowns are most popular when mortgage rates are elevated and buyers are looking for ways to improve affordability without waiting for rates to fall.
When a mortgage buydown may not be a good fit
A buydown may not make sense if:
- You’re short on cash after covering your down payment and closing costs
- You plan to sell or refinance in the near future
- You’d rather use that money to increase your down payment
In some cases, putting extra cash toward your down payment or keeping it in savings may provide more flexibility than locking it into discount points.
Types of mortgage buydowns
There are three common arrangements for temporary mortgage buydowns: the “3-2-1 buydown”, the “2-1 buydown”, and the “1-0 buydown.” Find out how each of these options works below:
What is a 3-2-1 buydown?
A 3-2-1 buydown allows the borrower to pay lower interest rates for the first three years of the loan. In the first year, the interest rate is three percentage points less than the current rate, increasing by a percentage point each year for the next two years. For the fourth year, the rate will match the rate you locked in at the start of your mortgage.
Review the chart below to see how a 3-2-1 mortgage buydown would impact the buyer’s monthly mortgage payment on a $400,000 30-year loan with an interest rate of 6%.
| Year | Interest Rate | Monthly Payment | Monthly Savings | Annual Savings |
|---|---|---|---|---|
| 1 | 3% | $1,686 | $712 | $8,544 |
| 2 | 4% | $1,910 | $488 | $5,856 |
| 3 | 5% | $2,147 | $251 | $3,012 |
| 4-30 | 6% | $2,398 | $0 | $0 |
The number of mortgage points charged for the buydown will vary from lender to lender. However, you’ll find that the buydown cost is typically about the same amount the buyer will save in interest. Using the example above, the mortgage buydown cost around $17,412.
What is a 2-1 buydown?
A 2-1 mortgage buydown is similar to the 3-2-1 structure, except the discounted rate is only for the first two years of the loan’s term. This would give the buyer an interest rate that is 2% less than the standard rate in the first year and 1% less in the second year.
Using the same example above, taking a $400,000 30-year loan with a standard interest rate of 6%, let’s look at how a 2-1 buydown would play out.
| Year | Interest Rate | Monthly Payment | Monthly Savings | Annual Savings |
|---|---|---|---|---|
| 1 | 4% | $1,910 | $488 | $5,856 |
| 2 | 5% | $2,147 | $251 | $3,012 |
| 3-30 | 6% | $2,398 | $0 | $0 |
In the first two years of the loan term, the buyer will save approximately $8,868 in interest. Knowing this, we can expect the cost of the 2-1 buydown to be around the same.
What is a 1-0 buydown?
A 1-0 buydown is a 1% reduction in interest rates in just the first year. Check out the chart below to see how this structure pans out throughout a $400,000 30-year loan.
| Year | Interest Rate | Monthly Payment | Monthly Savings | Annual Savings |
|---|---|---|---|---|
| 1 | 5% | $2,147 | $251 | $3,012 |
| 2-30 | 6% | $2,398 | $0 | $0 |
Use a monthly mortgage calculator for an estimated monthly payment for varying interest rates.
Pros and cons of mortgage buydowns
Under the right circumstances, a mortgage buydown can be a great option for both homebuyers and sellers. Understanding your situation and being aware of the costs involved can help you avoid some of the potential pitfalls.
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Who pays for a mortgage buydown?
While the buyer will ultimately benefit from a mortgage buydown, sellers and builders can also choose to purchase discount points to lower the buyer’s interest rate.
Cover the cost yourself
A mortgage buydown is typically negotiated between a buyer and their lender. If you have additional cash after budgeting for your down payment, you can use this money to buy mortgage points upfront in return for a lower interest rate.
Ask the seller to pay for it
If a seller needs to sell their home quickly or is selling in a buyer’s market, they may offer to pay for a mortgage rate buydown as an incentive to buy their home. If this is the case, the seller will make a one-time deposit into escrow or pay points over the entirety of the loan as part of seller concessions, or the closing costs the seller has agreed to pay. This money provides the mortgage lender with the funds to lower the buyer’s interest rate so they can more easily afford the home. However, the seller may try to tack on the cost of buying down the mortgage to the purchase price of the house to make up for the expense.
Use a builder closing cost incentive
Homebuilders may offer financing incentives for buying their newly built properties. You can use the funds to cover closing costs, including buying down your rate.
Use gift funds
If a family member or close friend has gifted you funds, you can apply this money to a mortgage rate buydown. However, there are restrictions on the amount you may receive as a gift without incurring a gift tax.
FAQs about mortgage buydowns
What are some alternatives to mortgage buydowns?
Adjustable-rate mortgages (ARM) and refinancing are potential options for those looking to save on their mortgage payment.
Keep in mind that both are dependent on fluctuations in the market rate. Refinancing is only worthwhile if interest rates fall, while an ARM can leave you on the hook for a higher payment if rates increase.
What are other ways to lower my interest rate?
If you’d like to decrease your interest expense without paying extra money upfront, you can start by taking steps to increase your credit score. A higher score can land you a lower interest rate on your mortgage, lowering your monthly payment.
Consult your mortgage lender
Be sure to work with your mortgage lender to find the best mortgage buydown arrangement for you, or if a mortgage buydown makes sense at all for your situation.
Redfin does not provide legal, tax, or financial advice. This article is for informational purposes only and is not a substitute for professional advice from a licensed attorney, tax professional, or financial advisor.
