We sat down with Troy Reichert, from the Reichert Mortgage Team, to discuss interest rate buy downs. What are they? Are they worth the cost? When are they beneficial? Who pays for them? We answer all of these mortgage questions and more! If you’d like to see our part one of this mini series, click here.
Interest Rate Buy Down
As defined by Rocket Mortgage, an interest rate buy down is a way for a borrower to obtain a lower interest rate. You do so by paying discount points at closing, also referred to as mortgage points or prepaid interest points. These are a one-time fee paid upfront. In the case of discount points, the interest rate is lower for the loan term.
For example, a mortgage lender may offer a borrower the ability to reduce their interest rate by .25% in exchange for a point. So, if the borrower is obtaining a mortgage for $400,000 and is offered an interest rate of 4%, paying $4,000 would lower their interest rate to 3.75%.
Due to higher interest rates over the last couple years, temporary buydowns are being heavily marketed in the world of mortgages. A 2-1 temporary buydown means for two years, you will have a lower interest rate. However, that interest rate will increase every year until you reach the current market rate that you’re locked into.
For instance, for the first year of your loan, you’re going to be two percentage points lower than what you would normally get in the market. If interest rates on a conventional loan are set at 6.25%, you’d be paying 4.25% for the first year. Then, on the anniversary of your loan origination, the interest rate will bump up to 5.25%, and so on until you top out at that 6.25%, where it will stay for the life of the loan.
Buyers have to qualify at the max interest rate, but the
temporary buydown provides a two year cushion within your lifestyle to absorb that higher mortgage payment. Here are some scenarios where the buydown is beneficial:
- you’re receiving a promotion at work and know you can afford the future higher payment
- interest rates are on their way down and you anticipate refinancing at a lower rate
- less income tied up in mortgage payments allows you to build up savings or pay off debt
A permanent buydown lowers the interest rate for the life of the loan. Whether a friend or family member contributes the money for the buydown is entirely up to the individual. In some cases, buyers can negotiate into the terms of the contract that the seller will pay. For buyers to pay for their own buydown, it can take years to recoup that cost, so it’s important to weigh risk versus reward. If you’re purchasing a home as a long term investment, it will absolutely pay off in the long run. In contrast, if your home is a short-term investment, using your cash toward a buydown may not provide a great return.
What are the benefits of a permanent buydown? Let’s say a buyer falls in love with a home. They don’t qualify at the current rate of 6.25%, but they would qualify at 5.75%. If they, or somebody willing, has the cash on hand, they can dedicate that money to getting a lower interest rate. Now, they’re locked into a lower rate that will not change. What it costs to buy down the interest rate will vary from person to person, based on purchase price and individual credit.
Real Estate Commissions
When it comes to mortgage questions, everybody wants to know: WHO pays for a mortgage rate buydown? As we stated before, friends and relatives can gift that money. Even your boss can contribute as a work bonus. Temporary buydowns must come from an interested party, meaning the buyer, seller, or realtor. It is most common that sellers contribute to temporary buydowns anyway, due to them being short term, thus cheaper. But, did you know realtors can offer part of their commission? Commission is always negotiable!
On average, on a $450,000 home, it will cost somewhere between ten and twelve thousand dollars to do a 2-1 buydown. There is an opportunity there for realtors on both sides of the transaction to combine their cash to reach that goal. The beautiful thing about a temporary buydown is that if rates go down, whatever money has not yet been used will go toward principal reduction. Which lowers their loan amount on a refinance. The buyer will not lose any of that $10,000-$12,000, even if they refinance. Therefore, there’s a whole lot of benefit to a temporary buydown with no downside.
Permanent buydowns can take as much as six to eight years to recoup the cost of what it takes to permanently lower your interest rate. In this case, buyers need to carefully and closely examine how long they anticipate staying in the home. As always, we recommend working with a professional to get as much information as possible, understand your options, and make the best decision that works for you.
About The Author
The team at My Front Range Living are a group of full time real estate experts serving Colorado Springs, El Paso County and the surrounding areas. Their knowledge of the local community and experience in the industry provide you incomparable value when buying or selling a home. With several years of experience in helping out of state buyers and sellers, they are the go-to team when it comes to relocating and helping Colorado feel like home.
Even if you’re looking for an agent in another city or state, the My Front Range Living team has a network of experts that can connect you with the right professional.
Colorado Springs Relocation Guide
🏡 Moving to Colorado Springs? Download our FREE Colorado Springs Relocation Guide!