Homebuyers

A Mortgage Rate Buydown Can Lower Your Monthly Payment: Here’s How It Works

Buying a home is one of the biggest financial moves you’ll ever make. And today’s savvy buyers are finding smart ways to make it work, even in a higher mortgage rate environment.

One of the best tools in their playbook: a temporary mortgage rate buydown.

A mortgage rate buydown lets you start homeownership with a lower mortgage interest rate and a smaller monthly housing payment for the first few years. And then the interest rate adjusts back to what it was when you took out the loan.

“It temporarily lowers your interest rate and your monthly payment for those number of years,” said Mychael Fields, a senior sales manager at New American Funding. He’s based in Novi, Mich.

For example, a 3-2-1 buydown would lower the interest rate by three percentage points in the first year of the loan, two points in the second year, and one point in the third year. Then the rate would adjust for the rest of the loan unless you refinance.

To get to that lower temporary rate, someone, usually the home seller or builder, makes an upfront payment.

What is a temporary mortgage rate buydown?

A temporary buydown is a financing strategy where an upfront payment lowers the payment rate on a home loan for the first one, two, or three years of your loan. The rate then adjusts to what it was when you got the mortgage.

That can make homeownership more affordable in your first years of homeownership.

How mortgage rate buydowns work

The most common structures are the 1-0, 2-1, and 3-2-1 buydowns. The numbers in the name tell you exactly how much your rate is reduced, and for how long.

With a 1-0 buydown, your rate is reduced by one percentage point for the first year, then returns to your original rate. It’s the most affordable buydown option and one of the most popular.

A 2-1 buydown shaves two percentage points off your rate in year one and one percentage point in year two, after which your full rate applies for the rest of the loan.

The most generous option is the 3-2-1 buydown. If mortgage rates were at 6% with this option, you would have a 3% rate in your first year of homeownership. That would go up to 4% in year two and 5% in year three. Then it would adjust to 6% for the remainder of your loan.

Who pays for a mortgage rate buydown?

Mortgage rate buydowns aren’t free. Someone pays the difference upfront, typically deposited into an escrow account that subsidizes your lower payments in the early years.

Most often, that’s the seller or a homebuilder, particularly in a buyer’s market where sellers are motivated to close the deal. Lenders can also offer buydowns.

How much can you save with a mortgage rate buydown?

How much you will save with a mortgage rate buydown depends on your loan amount, your interest rate, and your financial profile.

Here’s a rough look at what a 2-1 buydown might mean across different loan sizes. This assumes you have a 6.5% base rate.

* Numbers have been rounded.

The upfront cost of the buydown itself varies depending on the type of buydown and your financial situation.

A 1-0 buydown can cost between 75 to 125 basis points (0.75% to 1.25%) of the loan amount For a 2-0 buydown, the cost may rise to 100 to 125 basis points. For a 3-2-1 buydown, it may cost 125 to 150 basis points.

As an example, on a $300,000 mortgage, a 2-1 buydown at 100 basis points would cost around $3,000.

Is a mortgage rate buydown right for you?

A mortgage rate buydown could make sense if you’re stretched financially at closing and you need breathing room in those first years. But it’s not a one-size-fits-all solution. It's also worth exploring when sellers are motivated to close a deal and willing to negotiate.

“People need a plan,” Fields said. "People need to understand their budget and their plans for the future.”

If you plan to stay in the home only a few years, a buydown can help you save significantly before you sell. But if you’re settling in for the long haul, the upfront cost of the buydown and the eventual return to your full rate are important factors.

Other ways to lower your housing costs

A rate buydown is just one option. You might also explore adjustable-rate mortgages (ARMs), which start with a lower fixed rate for an initial period, generally five, seven, or 10 years. Then the rates adjust based on current rates every six to 12 months.

They carry more risk if rates rise but can work well for buyers who plan to refinance or sell before the rate adjusts.

Buyers may also want to purchase mortgage discount points. This permanently lowers your rate for the duration of your loan. Typically, for every quarter of a percentage point lower you want the rate to be, you pay 1% of the mortgage amount.

And don’t overlook negotiating directly with the seller. You may be able to ask the seller to cut the price, cover closing costs, or handle needed repairs. All of this can reduce what you're paying out of pocket.

Mychael Fields NMLS # 339585