In: Root » Legal and finance » Loans and mortgages
A buydown is a method of lowering the interest rate of a mortgage by paying additional points. There are two types of buydowns: permanent and temporary. A permanent buydown lowers the interest rate for the life of the loan, and a temporary buydown lowers the interest rate for the first few years. A permanent buydown is most often used as a sales incentive by the seller of a home. The seller (especially a homebuilder) will advertise "below market rate" financing as a special inducement to would-be buyers. Usually, the cost of the lower rates are factored into the asking price of the house. (Large builders also have other ways of offering low rates. They often can negotiate lower rates with lenders because of the large volume of loans.) In negotiating to buy a home, you may write a clause into the sales contract that requires the seller to pay up to a certain number of points for your mortgage. This is common with FHA and VA loans. The seller is, in effect, buying down your interest rate. The cost of a buydown varies depending on the type of loan and the lender. To lower the interest rate of a 30-year loan by 1 percent for the life of the loan, you usually will be charged from six to eight points. Temporary buydowns lower the interest rate (and monthly payment) for the first few years of a loan. Temporary buydowns are used like a graduated payment mortgage to help a borrower qualify for a higher loan amount than his or her income would allow with a level payment mortgage. Unlike GPMs, there is no negative amortization with a temporary buydown. The additional points pay for the lower initial interest rates. The "3-2-1" buydown is the most common type of temporary buydown. A 9 percent loan with a 3-2-1 buydown would have a 6 percent rate for the first year, 7 percent for the second year, 8 percent for the third year and 9 percent for years 4 through 30. Another popular temporary buydown is the 2-1 buydown. It reduces your interest rate 2 percent in the first year and 1 percent in the second year. It does not cut your initial payment as much as the 3-2-1 buydown, but it costs only about half as much (about three points). A buydown is an expensive way to reduce your initial payments, but you can use two methods to offset the up-front costs of a buydown. First, negotiate to have the seller pay for some or all of the buydown costs. It is very common for homebuilders to pay buydown costs for buyers. Second, your lender may allow a "buyup" in the loan's base interest rate to offset the cost of the temporary buydown. For example, if the market rate for a 30-year fixed-rate loan is 8 percent plus two points, you might expect to pay five points for an 8 percent rate with a 2-1 buydown. Some lenders will offer an 8.5 percent rate with a 2-1 buydown for two points. The first year rate would be 6.5 percent, the second-year rate would be 7.5 percent, and the remaining payments would be at a rate of 8.5 percent.
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