Buydown to Reduce Your Mortgage Interest Rate

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If you’re buying a home, you may be searching for ways to reduce your monthly mortgage costs. Common options include making a larger down payment or improving your credit score to qualify for a lower rate. Another option is a buydown, which lets you pay to lower your interest rate.

Buying mortgage points means you pay a fee upfront to reduce your loan’s interest rate. Each point costs 1% of the total loan amount. Here’s an example.

Sally wants to buy a $500,000 home. She plans to put down $100,000, and her lender offers a 30-year fixed loan at 3.75%. Sally wants a lower rate to save more during the early years of the loan, when interest costs are highest. Her lender says she can buy one point for $4,000, which will reduce her rate by 0.25%. Sally decides to buy the point and receives a 3.5% interest rate.

Most buyers choose to buy their own points, but sellers may offer to cover the cost to make their home more appealing. This often happens in a buyer’s market, when sellers need to offer incentives. Builders may also use this strategy to help sell new homes.

What is a 3-2-1 buydown?

A 3-2-1 buydown lowers the interest rate for the first three years of the loan. The rate rises each year until it reaches the original rate in Year 4. If the rate changes in 0.25% steps, the first year will be 0.75% lower, the second year 0.5% lower, and the third year 0.25% lower. A 2-1 buydown works the same way but lasts two years instead of three.

What is an interest rate reduction?

If the lower rate applies for the entire loan term, it’s called an interest rate reduction. This option usually costs more upfront, but the long-term savings can be substantial, especially on a long mortgage.

When should you buy points?

To decide whether buying points makes sense, calculate how long it will take to recover the upfront cost. Divide the cost of the points by the amount you’ll save each month. The result is your breakeven point. If you plan to sell the home before that time, buying points may not be worthwhile. If you must choose between a larger down payment or buying points, increasing your down payment is often the better option.

Some loans don’t allow buydowns, such as certain investment properties or cash-out refinances. Always check with your lender to see what options you qualify for.