An interest rate buydown will decrease the interest rate for the first 1-2 years. There exists in the mortgage industry both a 1 year buydown and also a 2-1 buydown.
For example in a 1 year buydown, let’s say the starting interest rate is 6%. For the first year, thanks to the buydown, the interest rate and the first 12 payments are based on a 5% interest rate.
In a 2-1 buydown, the first 12 payments are at 4%, payments 13-24 are at 5% and beginning with payment 25 and thereafter, the payments are at 6%.
And so, the homebuyer has an opportunity to have a lower interest rate for the first 1-2 years of the loan and thus, a lower payment at the outset.
First Home Mortgage currently offers the 2-1 buydown and the 1 year buydown. Recently, mortgage companies have marketed buydowns more so than in the past because with higher interest rates in 2022, a buydown allows a lender or seller to market a lower starting interest rate. The lower interest rate is temporary and there is a cost for the buydown.
A buydown is commonly paid for by a seller credit. Learn more about seller credits here: https://alexjaffe.com/seller-credits
A seller credit can be used for many things, including paying for closing costs, buying points, prepaying condo fees and an interest rate buydown. Learn more https://alexjaffe.com/points and https://alexjaffe.com/closing-costs
If a homebuyer believes that higher interest rates are temporary and there may be an opportunity to refinance in the future, a buydown might be interesting to them due to the initial interest rate and payment.
The cost of a buydown is the difference in the interest of that 1-2 year period. This cost is paid upfront, usually by the seller. It is a marketing tool more commonly used by new construction builders than in resales.
When you calculate the cost of a buydown, and view that as a sales concession, a homebuyer would be wise to consider using the funds either as a closing cost credit, sales price reduction or in buying points which offers a permanent reduction in the interest rate.
It’ll be my duty to help a homebuyer understand what is possible and decide what is best for them.
On a $400,000 loan, here below are the monthly payments based on these interest rates:
$2,398.20 at 6%
$2,147.29 at 5%
$1,909.66 at 4%
(These are just the mortgage payments- tax and insurance are additional.)
A 1 year buydown in this example will cost $3,010.92 to buydown the rate from 6% to 5% for the first year.
A 2-1 buydown in this example will cost $8,873.40 to buydown the rate from 6% to 4% for the first year and 5% for the second year.
When we qualify a homebuyer, we qualify them for the payment at the permanent rather than the bought down interest rate. Buydowns used to be much more common in 2003-2008 because back then, we qualified at the bought down interest rate.