Mortgage buydown: What it is and how it works

Mortgage buydown: What it is and how it works

08.18.2023

When you’re shopping around for a mortgage, the interest rate is one of the most important factors. A higher interest rate can add hundreds — or thousands — of dollars to your mortgage payment and can significantly increase the cost of the loan over the long term. 

A mortgage buydown is a strategy that allows buyers to buydown their mortgage interest rates, at least for a certain period. While doing so can save you money on your mortgage payment, it does require an upfront cost and may not be a permanent rate discount. If you’re considering buying a house and are anxious about today’s high interest rates, keep reading to learn about how a mortgage buydown can help and whether it’s the right choice for you. 

What Is a mortgage buydown? 

A buydown is a way for a home buyer to lower their mortgage interest rate for the first few years of their mortgage in exchange for an upfront fee. A buydown is most often paid for by the seller or builder as a concession to help close the deal. 

When someone uses a buydown, their interest rate will be reduced for a predetermined period of time. This type of financing arrangement can be especially beneficial right now when mortgage interest rates are high. Additionally, they are particularly helpful in the first few years of a mortgage when most of the monthly payments are going toward interest. 

How does a buydown work? 

Mortgage buydowns are temporary financing arrangements that can be structured in a few different ways. Here are some of the most common buydown structures: 

  • 3-2-1 buydown: Your interest rate is reduced by 3% for the first year. It will then increase by 1% per year for the next three years. You’ll start paying the full interest rate in the fourth year. 
  • 2-1 buydown: Your interest rate is reduced by 2% in the first year and then increases by 1% per year for the next two years. You’ll start paying the full interest rate in the third year. 
  • 1-1 buydown: Your interest rate is reduced by 1% in the first year and increased by 1% in the second year. You’ll start paying the full interest rate in the second year. 

Mortgage buydown example 

Suppose you’re buying a home with a market value of $300,000 with a 30-year mortgage and an interest rate of 7%. Based on those numbers, your monthly principal and interest payment would be $1,995. 

Now let’s say you and the seller negotiate a 3-2-1 buydown. The seller pays the fee as a concession, which will help save you money for the first few years of homeownership. In the first year of the mortgage, you pay 4% instead of 7%, meaning your mortgage payment is only $1,432. 

In the second year, your interest rate increases to 5%, and your payment increases to $1,610. In the third year, your interest rate increases to 6%, and your payment increases to $1,798. It’s not until the fourth year of the mortgage that your interest rate reaches 7%, and you pay the full monthly payment. Your total interest savings would be roughly $13,750 over three years. 

Pros and cons of a mortgage buydown 

A mortgage buydown offers plenty of benefits, but there are also some downsides you should know about before going forward with one. 

Pros 

  • Interest savings: When you use a mortgage buydown, you’re able to save thousands of dollars in interest during the first few years of your mortgage. 
  • Lower monthly payment: A buydown helps you get a lower monthly payment during the first few years, which can help you ease into paying a mortgage. 
  • Negotiation tactic: A buydown can be a negotiation tactic for sellers who want to close the deal without coming down in the price of the house. 

Cons 

  • Upfront fees: Buydowns require large upfront fees, usually paid by the seller or builder. Because the fees are so steep, sellers and builders may be less likely to offer them. 
  • Temporary: Buydowns typically aren’t permanent — they typically last anywhere from one to three years. 
  • Default risk: The increase in mortgage payment could come as a surprise for some buyers and increase their chances of not being able to pay their mortgage. 

Is a mortgage buydown a good idea? 

A mortgage buydown can be a good idea, but it’s not right for everyone. If you’re a buyer and a seller or builder offers a buydown to help make the deal seem more enticing, it could be worth taking it. After all, you’ll save thousands of dollars on your mortgage payments — all on someone else’s dime. 

However, you should only use a mortgage buydown if you feel confident you can afford the mortgage payment with the full interest rate. Unfortunately, the increase in interest rate can come as an unwelcome surprise to homeowners. And if you haven’t run the numbers with the higher payment, you could find that it’s actually not affordable for you long-term. 

Finally, know that not all loans offer buydowns, so it may not be an option available to you anyways. Some lenders may not offer buydowns for conventional loans. And government-backed loans have more specific guidelines for the use of buydowns, meaning they aren’t available to everyone. 

Finally, while a mortgage buydown can save you money, there are more cost-effective and permanent ways of doing so, such as by buying discount points, which we’ll discuss in the next section. 

Mortgage buydown alternatives 

A buydown can be one way to save money on your mortgage payment, but it’s not the only way. Here are a few alternatives to consider: 

  • Discount points: These are similar to a mortgage buydown but not quite the same. They still involve an upfront fee. However, the fee is usually much lower than the fee for a buydown, and discount points are a permanent way of reducing your interest rate rather than a temporary one. 
  • Adjustable-rate mortgage (ARM): An ARM has an interest rate that fluctuates with the market rate. ARMs generally start with lower interest rates than fixed-rate loans, offering upfront savings. However, you could see your interest rate rise significantly in the future. 
  • Refinancing: If you are buying a home in a high interest rate environment, you might consider refinancing down the road when rates are lower. This plan won’t necessarily help you save money right away but can help you pay less in interest in the long run. 

The bottom line 

A mortgage buydown is a way of lowering your mortgage interest rate for the first few years of your loan. It’s different from discount points, which allow you to permanently lower your rate. You typically wouldn’t pay for a mortgage buydown yourself — a seller or builder might offer one to entice you to buy their home. And while they can save you thousands of dollars, they aren’t right for everyone or in all situations.

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The Currency editors

Staff contributors

The CurrencyTM, a publication from Empower, covers the latest financial news and views shaping how we live, work, and play. We keep you current on ways to plan, save, and invest for life.

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