Key Takeaway: Buying down the interest rate on your mortgage means you or someone else like a lender or seller pays an upfront cost to lower the rate of your home loan. A temporary buydown only lasts one to three years, but a permanent buydown can help you save money over the long haul by purchasing discount points.
You can buy down the interest rate on your mortgage by paying money upfront in exchange for receiving a lower rate on your home loan. A temporary buydown lowers the interest rate on a home loan for a short time, typically one to three years. A permanent buydown uses mortgage point purchases to lower the rate for the life of the loan.
A mortgage rate buydown may be worth considering if you want lower monthly payments early on or a lower rate for the entirety of the loan term. Temporary buydowns are often paid by a seller, builder or lender as an incentive, while permanent buydowns are usually paid by the buyer.
Whether a buydown makes sense financially comes down to who pays for it and how long you plan to stay in the home.
- What is a mortgage rate buydown?
- What are the types of temporary rate buydowns?
- How to pay for an interest rate buydown
- Should I buy down my mortgage rate?
- What is the difference between a buydown and an ARM?
- What is the difference between a temporary buydown and buying discount points?
- FAQs about interest rate buydowns
What is a mortgage rate buydown?
A mortgage rate buydown is when someone pays money upfront to lower the interest rate on a home loan. There are two main types: a temporary rate buydown and a permanent rate buydown.
What is a temporary mortgage rate buydown?
For a temporary mortgage rate buydown, someone who’s involved in a home sale (often a buyer, lender, seller or builder) pays money upfront to reduce the buyer’s interest rate early in the life of the mortgage. The money goes to an escrow account, and some of it is used to subsidize the mortgage payment each month that the buydown is in effect.
A buydown gives the buyer a lower interest rate and lower mortgage payments for a set time period that generally lasts one to three years. After this period ends, the interest rate goes up to a higher rate for the remainder of the loan term. The mortgage payments also rise to a higher level.
What is a permanent mortgage rate buydown?
A permanent mortgage buydown lowers the interest rate for your entire loan term. You can do this by buying discount points. You’ll have to pay upfront for these points when you close on your home loan, but the cost savings over time may be worth it if you stay in your home long enough to reach your “break even” point.
According to the Consumer Financial Protection Bureau, one point typically equals 1% of your loan amount — so on a $400,000 loan, one point costs $4,000. You can also buy fractional points, such as 0.5.
But keep in mind that exactly how much your rate will go down for every point you buy depends on factors such as the lender, loan type and overall mortgage market.
What are the types of temporary rate buydowns?
There are a few types of temporary buydowns. All of them lower your interest rate temporarily, but they differ in how much they reduce the rate and how long the savings last.
1-0 buydown
A 1-0 buydown gives you an interest rate that’s lower by 1% than the rate you’ve agreed to pay for the remainder of the loan term, with the savings in effect for the first year. In the second year and onward, your interest rate returns to the rate specified in your mortgage note.
Here’s how a 1-0 buydown works for a 30-year fixed-rate mortgage with a $400,000 loan amount at a contract rate of 6.75% interest.
1-0 mortgage rate buydown example
| Interest rate | Monthly payment | Monthly savings | Yearly savings | |
|---|---|---|---|---|
| Year 1 | 5.75% | $2,334.29 | $260.10 | $3,121.20 |
| Year 2 | 6.75% | $2,594.39 | 0 | 0 |
2-1 buydown
A 2-1 buydown reduces the interest rate for the first two years of the loan. In the first year, the interest rate is 2% below the contract rate. The interest rate then rises and is 1% below the contract rate for the second year. In the third year and onward, the interest rate equals the contract rate.
Here’s an example of a 2-1 buydown for a 30-year fixed-rate mortgage with a $400,000 loan amount at a contract rate of 6.75% interest.
2-1 mortgage rate buydown example
| Interest rate | Monthly payment | Monthly savings | Yearly savings | |
|---|---|---|---|---|
| Year 1 | 4.75% | $2,086.59 | $507.80 | $6,093.60 |
| Year 2 | 5.75% | $2,334.29 | $260.10 | $3,121.20 |
| Year 3 | 6.75% | $2,594.39 | 0 | 0 |
3-2-1 buydown
A 3-2-1 buydown gives the borrower an interest rate that’s 3% lower than the contract rate in the first year, 2% lower than the contract rate in the second year and 1% lower than the contract rate in the third year. Starting with the fourth year, the borrower pays the contract interest rate.
A 3-2-1 buydown for a 30-year fixed-rate mortgage with a $400,000 loan amount at a contract rate of 6.75% interest works like this.
3-2-1 mortgage rate buydown example
| Interest rate | Monthly payment | Monthly savings | Yearly savings | |
|---|---|---|---|---|
| Year 1 | 3.75% | $1,852.46 | $741.93 | $8,903.16 |
| Year 2 | 4.75% | $2,086.59 | $507.80 | $6,093.60 |
| Year 3 | 5.75% | $2,334.29 | $260.10 | $3,121.20 |
| Year 4 | 6.75% | $2,594.39 | 0 | 0 |
How to pay for an interest rate buydown
There are a few different ways to cover the cost of an interest rate buydown.
Pay cash
If you have enough cash on hand to make a large upfront payment, you can pay for an interest rate buydown yourself.
Paying for a temporary buydown yourself means paying some of your interest ahead of time. The amount you pay upfront equals your savings later, so you aren’t gaining anything by doing this.
Discount points, on the other hand, are typically paid by the buyer at closing — though a seller can contribute toward them as a concession. Either way, compare a buydown offer against a similar mortgage without one to see which costs less over the long term.
Ask the seller to pay
Sellers may agree to pay for a temporary buydown as a concession. A seller is more likely to say yes to a request like this if the housing market is sluggish and they’re struggling to find a buyer.
Check if your builder offers incentives
Some home builders will pay for temporary buydowns as an incentive when sales are slow.
Find a lender that funds buydowns
Lenders can use temporary buydowns to reduce your initial costs from a mortgage. But you should compare a buydown offer with a similar mortgage that doesn’t include a buydown to see which one costs more over the long term.
Should I buy down my mortgage rate?
Paying for a temporary buydown yourself is a way to pay some interest for the first few years of the loan ahead of time. You might want to do this if you have cash to spare, you want to get a head start on paying interest and you don’t expect to stay in the home long enough to benefit from permanently buying down your rate.
If you have extra cash to spend at closing and you plan to remain in the home for several years, it might make more sense to buy points for a permanent rate decrease. If you buy points, you could ultimately save more money than you spend upfront if you stay in the home long enough.
Accepting a temporary buydown could be worth it if it’s paid for by the seller, builder or lender. You’ll want to compare your overall interest and fees with and without a buydown to make sure the buydown saves you money in the long term.
What is the difference between a buydown and an ARM?
An adjustable-rate mortgage, or ARM, is a home loan that has a fixed rate for a number of years at the beginning of the loan. This rate is usually lower than rates on fixed-rate loans. After the fixed period, the rate changes at regular intervals in line with changes in interest rates throughout the economy. The interest rate you pay during the adjustment period might be higher than the rate for the fixed period, even if overall rates in the economy don’t move around much.
An ARM can be risky because you don’t know in advance how high your interest rate and payments will be during the adjustment period. It could be hard to afford the payments after your interest rate rises. In contrast, if you get a fixed-rate mortgage with a temporary buydown, you know from the start exactly how much you’ll pay for the entire loan term.
On the other hand, ARMs have an advantage over temporary rate buydowns because the initial rate can apply for a longer period of time. The fixed period on an ARM can last between five and 10 years, while a buydown typically gives you a lower rate for just one to three years. This could make an ARM a better choice if you expect to sell your home by the end of the ARM’s fixed period.
What is the difference between a temporary buydown and buying discount points?
Buying discount points is a way to permanently lower the interest rate on a mortgage. While a temporary buydown typically reduces the rate on the mortgage for the first one, two or three years, buying discount points at the loan closing gives you a reduced rate for the entire life of the loan.
Temporary buydowns generally reduce the interest rate by standard amounts such as 1%, 2% or 3%, but the rate reduction from discount points varies by lender and depends on conditions in the mortgage market. Paying for discount points usually doesn’t lower the mortgage rate as sharply as a temporary buydown. For example, buying one discount point might trim 0.25% off the rate.
Next steps
Ask yourself some questions as you consider a rate buydown.
- How long do I plan to stay in the home? If you want to stay in your home longer than a few years, you’ll either need to refinance or face increased payments when your buydown ends.
- Is my income likely to change in the future? If you’re transitioning into a higher-paying career, you might feel more confident about making higher mortgage payments once the buydown ends. On the other hand, if you work in an industry that’s experiencing uncertainty or layoffs, you might not want to risk a jump in payments later.
- What are the alternatives? You could look into an ARM or buying a less expensive property. You might also want to consider other types of seller-paid incentives, like asking the seller to make repairs or upgrades to the home.
FAQs about interest rate buydowns
A temporary buydown lowers your rate for the first one to three years before it rises to the rate specified in your mortgage contract. A permanent buydown, also known as buying discount points, lowers your rate for the entire loan term. Temporary buydowns are often paid by a seller or builder, but points are usually paid by the buyer.
For a permanent buydown, one discount point costs 1% of your loan amount, or $4,000 on a $400,000 loan. One point often lowers the rate by about 0.25%. For a temporary buydown, the cost equals the total payment savings, funded upfront into an escrow account.
A temporary buydown is usually worth it if someone else like a seller, builder or lender pays for it. A permanent buydown may be worth it if you keep the loan long enough to pass your break-even point, where monthly savings outweigh the upfront cost.
Temporary buydown can be financed by the borrower, lender, employer, seller or other interested parties — most often the seller or builder as a concession. Permanent buydowns for discount points purchases are typically paid by the buyer.
Yes. Discount points permanently reduce the interest rate on your mortgage note. A temporary buydown does not — Fannie Mae’s guidelines require the full rate and payment to still appear on the loan documents. A rate buydown just subsidizes the payment early on.