When you “buy down” your mortgage interest rate, you pay the lender in advance in exchange for receiving a lower interest rate on your loan. The buydown can be short-term or it can be for the whole length of the loan.
In Charlotte, mortgage buydowns are a great way for buyers to afford a higher purchase price, but not everybody knows about this mortgage feature.
What is a buydown?
A buydown is a mortgage agreement that reduces the interest rate on the home loan.
Some buydowns only affect the rate at the beginning of the home loan. After a set period of time, the interest rate rises to the regular rate, where it stays until the loan is paid in full.
For instance, 2-1 buydowns are a common format. The “2-1” means that for the first year, the rate is lowered by two percentage points. For the second year, the rate is lowered by 1 percentage point. Then it’s the regular, permanent rate for the remainder of the loan term, which is usually 30 years.
How does a buydown work?
Here’s an example of how a buydown works. Say you’re buying a house in one of Charlotte’s new home communities. Your monthly payment at current rates would be a bit of a stretch, but you know your income will keep rising over time. You might consider a buydown as a way to lower those payments and qualify for a larger home loan.
Say you consider a 7% home loan with a 3-2-1 buydown.
Your first year in your new home, your mortgage rate would be 4% (7-3=4).
Your second year, it would be 5% (7-2=5).
Your third year, it would be 6% (7-1=6).
Then, beginning in the fourth year of homeownership, your interest rate would be 7%, and it would stay there for the rest of the mortgage. But for those first three years, you would save hundreds of dollars each month thanks to the lowered interest rate you achieved with the buydown.
Benefits of mortgage buydowns
When you choose a mortgage with a buydown, your monthly payment can go down as well, because you’re not paying that additional interest.
That could free up hundreds of dollars a month, money you could use to furnish your new home, pay for upgrades or repairs, or install new landscaping or appliances.
Take a look at our Mortgage Calculator to see how different interest rates can affect your payment.
For instance, a $300,000 loan at 7% has monthly payments of $1,995. But at 4%, your monthly payment would be $1,432. That’s a difference of $563 each month — for a year.
Another benefit of a mortgage buydown is that it can help you afford a mortgage on a home you love while you wait for your income to keep up. If you’re expecting a steady career path and expect regular future raises, a mortgage buydown lets you begin the mortgage process with mortgage payments you can afford. Then, when your mortgage rate rises, your income is already rising to keep up.
Buydowns also help people qualify for larger loans, increasing their purchasing power while decreasing their monthly payments.
Temporary vs. permanent buydown
There are two main types of buydowns: temporary and permanent.
Temporary buydowns lower the mortgage rate for just a few years at the beginning of the loan. A 2-1 or 3-2-1 buydown is a temporary buydown. After a short time, the rate rises to the regular rate and stays there.
Permanent buydowns let you finance discount points into the loan, resulting in a lowered rate for the whole length of the mortgage. Buying down your rate like this might even let you secure a lower rate than what’s available on the loan market.
And with a permanent buydown, you don’t have to pay additional cash at the closing — the cost for the buydown can be rolled into the loan.
You can often get permanent buydowns for both fixed-rate and variable-rate mortgages such as ARMs (adjustable rate mortgages). Buydowns are an option for refinancing and mortgages on second homes, too.
Buydowns vs. ARMs
Both a buydown and an adjustable-rate mortgage are ways to pay less at the beginning of your home loan. With a temporary buydown, your interest rate will rise at a predetermined rate and time.
But with an ARM, you often can’t predict what will happen when it’s time for your mortgage rate to reset. Your ARM may start with an attractive rate for the first few years (three, five, seven, or 10)— but after that, the rate changes in tune with overall market rates, which can be unpredictable. There’s a chance your ARM could reset to a rate you’re not comfortable with.
Unlike ARMs, a mortgage buydown is predictable and clearly spelled out, so you can more easily plan your finances.
How you can benefit from a buydown
If you’re concerned about qualifying for a mortgage, a buydown could be the answer. With a buydown, you can qualify for the lower rate of interest. Sellers might offer a rate buydown as a selling point, and sometimes home builders do as well.
Anything you can do that tips the scales of homeownership in your direction is worth checking out. When you’re ready to get pre-approved, the knowledgeable mortgage planners at Fairway are here to help. You’ll be making confident mortgage decisions in no time!
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