You may have heard the term “rate buydown” on your new home search in Austin, Houston or San Antonio, but what does it mean? We asked Benito Solis of Cornerstone Home Lending to give us the details on how this financing arrangement works to help you understand its benefits.
What is a Rate Buydown?
A buydown is a way for a borrower to obtain a lower interest rate by purchasing discount points against their mortgage loan or paying interest upfront at closing. It allows them to make lower mortgage payments during higher interest rate conditions either for the first few years of their loan or for its full life, depending on which structure is chosen.
How it Works
Depending on your overall goals, this is a great way to reduce your monthly mortgage payment without taking on additional risk with other loan options such as Adjustable-Rate Mortgages (ARMS) since buydowns are fixed-rate programs. They can also be used on almost all loan types such as VA, Conventional and FHA, and the prepaid interest required upfront is usually paid for by the seller.
“One of my favorite features of buydowns is that any upfront interest you paid or anyone paid on your behalf is never lost,” says Solis. “If you choose a 3-2-1 buydown and rates fall in year two, the remaining upfront interest that isn’t used will be deducted from your loan balance.”
Types of Rate Buydowns
While there are a few rate buydown structures to choose from, the most common are 3-2-1, 2-1, and permanent rate buydowns. With a 3-2-1 program, monthly mortgage payments will be at their lowest in the first year and will increase slightly in the following two years. The full interest rate will come into effect in the fourth year of the loan.
A 2-1 buydown is very similar in that it has the same permanent payment structure as a 3-2-1 buydown, but the full interest rate comes into effect in year three. In most cases, a 2-1 buydown will cost fewer points than a 3-2-1 buydown, but the savings will also be less.
While a 3-2-1 and 2-1 buydown will temporarily reduce your mortgage payments, a permanent buydown will lower the interest rate for the entire life of your loan. Take a look at our examples below illustrating how these rate buydown structures work.
The Benefits
Buydowns reduce your interest rate, making your dream home that much more attainable. In today’s market, they allow you to take advantage of low home prices and low payments, saving you money and allowing you to qualify more easily for your mortgage.
If you choose a 3-2-1 or 2-1 buydown structure and rates drop, you can refinance at any time with no pre-payment penalty. Any remaining funds being held in your escrow account will not be lost and will be applied to your principal balance.
Is it Right For Me?
When it comes to finances, the best way to determine what’s right for you is to speak with a Mortgage Loan Officer. These industry experts can point you in the direction of the best financing options based on your individual scenarios, goals and needs.
Next, discover the benefits of working with one of our preferred lenders, the 5 financing myths you should know and what to know about the homebuying process in Texas.