A buydown temporarily reduces your interest rate, saving you money and lowering your monthly payments during the initial loan term. Choosing a buydown may allow you to pay less for the home than the seller's listing price. It could make sense for homebuyers whose income will increase in the years to come.
How does a seller-paid rate buydown benefit the seller? Raised interest rates can cause price reductions on a seller's home. A buydown is one way sellers can avoid this. It might be cheaper for them to help pay for mortgage or discount points instead of cutting the asking price of their home.
Why is it important to have a down payment? A down payment will reduce the loan amount, interest cost, and monthly payments. The amount of the down payment may also reduce the interest rate provided by the lender.
Pros and Cons of a 2/1 Buydown
First, it should be clearly understood that a 2/1 buydown is temporary. Initially, it can seem like a pro that you are paying a lower interest rate and, therefore, a lower monthly payment for those first two years. However, being ready for the higher payments in that third year is a must.
Either a homebuyer or a home seller can pay for a buydown. That payment may be in the form of mortgage points or a lump sum deposited in an escrow account with the lender and used to subsidize the borrower's reduced monthly payments.
Interest rates constantly change based on the economy. If rates have dropped since you took out your 2-1 buydown mortgage, refinancing could allow you to lock in a lower rate. Even a small decrease in the interest rate can significantly reduce your monthly payments and save you money over the life of your loan.
You'll need a down payment of $12,000, or 3 percent, if you're buying a $400K house with a conventional loan. Meanwhile, an FHA loan requires a slightly higher down payment of $14,000, equivalent to 3.5 percent of the purchase price.
You may qualify for a lower interest rate
Since you're assuming more of the financial risk, a 20% down payment puts you in a great spot to negotiate with your lender for a more favorable mortgage rate. A lower interest rate can save you thousands of dollars over the life of the loan.
It lowers the mortgage loan amount.
If you make a down payment that's 20% of the home's purchase price, the lender only has to lend you 80% of the purchase price.
Mortgage rate buydowns typically happen in one of two ways: The seller contributes to the buyer's closing costs via discount points, or the seller pays for a temporary rate buydown.
A higher down payment shows the seller you are motivated—you will cover the closing costs without asking the seller for assistance and are less likely to haggle. You are a more competitive buyer because it shows the seller you are more reliable.
Your lender will calculate the cost of any points you purchased and add them to your other closing costs. Generally, buying four mortgage points will lower your interest rate by 1 percent. That's also the maximum number of points most lenders will let you purchase.
In lieu of taking a lower offer or making other concessions, a seller can offer a buydown, which will lower the buyer's monthly mortgage payment — either temporarily or permanently — making the purchase more attractive.
Disadvantages of Buydown
Higher Upfront Costs: One of the main drawbacks of buydowns is the additional upfront costs involved. Borrowers must be prepared to pay for points or fees to secure the lower interest rate. This can require a significant upfront investment and may not be financially feasible for everyone.
And here is even better news: The money for the temporary buydown goes into an escrow account and is applied to your loan every month during the buydown period. If you refinance or sell during that period, the unused portion gets applied to your home loan, reducing the balance of your loan.
It's good practice to make a down payment of at least 20% on a new car (10% for used). A larger down payment can also help you nab a better interest rate. But how much a down payment should be for a car isn't black and white. If you can't afford 10% or 20%, the best down payment is the one you can afford.
If your down payment is lower, your monthly mortgage will be higher. It's simply a matter of math — the smaller the down payment, the larger the amount left over to divide into monthly mortgage payments.
To purchase a $200,000 house, you need a down payment of at least $40,000 (20% of the home price) to avoid PMI on a conventional mortgage. If you're a first-time home buyer, you could save a smaller down payment of $10,000–20,000 (5–10%). But remember, that will drive up your monthly payment with PMI fees.
To comfortably afford an $800,000 house, you'll likely need an annual income between $220,000 to $260,000, depending on your specific financial situation and the terms of your mortgage. Remember, just because you can qualify for a loan doesn't mean you should stretch your budget to the maximum.
The ideal candidate for a 2-1 buydown loan may be someone who: Has a partner or spouse who is going to go back to work in the next two years. Wants to lower their monthly payment for the first two years of being a homeowner so they can pay for improvements or repairs.
A 3-2-1 buydown is a mortgage financing technique that provides a temporarily reduced interest rate during the first three years of the loan. It's available for many loan types, including VA loans, though not every lender will provide this option.
With FHA 2-1 BUYDOWN, you can enjoy lower interest and mortgage rates. You will also have the option of buying down your interest rate for the first two years of homeownership. This means that you will get a rate that is two percentage points lower for the first year and one percentage point lower for the second year.