A buydown is a financing technique in which money is paid upfront to temporarily reduce a loan’s interest rate and lower the payment.
There is no savings to the buyer for creating a buydown if he or she pays for it. It’s really just prepaid interest. For example, a 2/1 buydown means the interest rate will be two percent lower for the first year, one percent lower for the second year, and back to its permanent rate in year three.
For a $100,000 mortgage at 4.50 percent, then, the first year’s payment will be based on a 2.5 percent rate, the second year’s will be based on a 3.5 percent rate, and the rate reverts to 4.5 percent for the duration of the loan. In the first year, then, the payment is $395. That’s $112 less per month than the $507 required by a 4.5 percent rate. During that year, then, the borrower will have paid $1,344 less.
The second year, the payment rises to $449 a month, $58 less than the full monthly payment. During that year, the borrower will have paid $696 less than the full amount. The total unpaid during those two years is $2,040, and the cost of the buydown is $2,040.
Buydowns can be part of the negotiation when buying a house; getting the seller or home builder to pay for it makes it easier for buyers to afford their new homes.