What Is a Mortgage Buydown and How Does It Work?
A mortgage buydown allows you to pay extra money upfront to secure a lower interest rate on your home loan. A reduced rate can save you thousands of dollars in lifetime interest and lower your monthly payments. Learn more about mortgage buydowns, including how they work, the different types and the benefits and risks to consider.
Key takeaways
- A mortgage buydown can help you secure a lower interest rate on your home loan.
- The reduced interest rate can be permanent or temporary, depending on the type of buydown you choose.
- A 2-1 buydown offers a lower interest rate for the first two years of your mortgage repayment.
How does a mortgage buydown work?
A mortgage buydown, also known as a mortgage rate buydown, involves paying an upfront fee in exchange for a lower mortgage interest rate. The rate reduction can either be temporary or permanent, depending on the buydown type (which we’ll discuss below). Mortgage buydowns can be particularly beneficial when interest rates are on the rise, as they help homebuyers reduce their monthly payments by locking in a lower rate.
The buydown payment can be made by the homebuyer, seller, builder or mortgage lender and is meant to help make your mortgage payment more affordable for the first few years. However, homebuyers should be prepared for a higher monthly payment once the buydown period ends.
A buydown mortgage is only available when buying or refinancing a primary residence or second home. Home sellers and builders often provide rate buydowns to make their properties more appealing to buyers. They are generally not available when purchasing an investment property or for cash-out refinancing.
Types of mortgage buydowns
There are several types of buydowns, though options vary by lender. Here’s an overview of some of the most common mortgage buydown options.
→ 2-1 buydown. A 2-1 buydown agreement provides a lower interest rate for the first two years of your mortgage. Typically, your rate is reduced by 2 percentage points in the first year and 1 percentage point in the second year, which is how this type of buydown gets its name. You’ll pay the full interest rate starting in the third year and for the rest of the loan term.
→ 3-2-1 buydown. With a 3-2-1 rate buydown, you receive a lower interest rate for the first three years of your home loan. Your rate is reduced by 3 percentage points in year one, 2 percentage points in year two and 1 percentage point in year three. For example, let’s say your original interest rate is 6%. In this case, your rate will be 3% in the first year, 4% in the second year and 5% in the third year. Starting in year four, you’ll be charged the full rate (6%) for the remainder of the loan term.
→ Permanent buydown. This type of buydown results in a lower interest rate for your entire loan term versus just the first few years. This option usually involves purchasing mortgage points.
One point typically equals 1% of the loan amount. For example, one point on a $400,000 loan would cost you $4,000 ($400,000 x 0.01). Generally speaking, each point reduces your interest rate by up to 0.25 percentage points.
Let’s say you buy a home for $400,000 with a 30-year mortgage, 7% interest rate and 20% down payment. Based on these numbers, your monthly principal and interest payment would be $2,129.Now, let’s assume you negotiate a 2-1 buydown with your lender. In the first year, your interest rate drops to 5%, and your monthly payment would be $1,718. During the second year, your interest rate increases to 6%, and your monthly payment would be $1,919. Starting in the third year, your rate and payment return to the original 7% and $2,129, respectively.
With a 3-2-1 buydown, you’re buying a rate that is 3% below the prevailing mortgage rates. Each number represents how much lower the rate is than the current rates. For example, let’s assume that you’re offered a 3-2-1 buydown at a cost of $12,750, and you’re approved to borrow $425,000 in a market where rates are typically 6% for a 30-year fixed-rate loan.
| Credit score range | $5,000 wedding loan payments | $8,750 wedding loan payments | $17,500 wedding loan payments | $35,000 wedding loan payments |
|---|---|---|---|---|
| 720+ | $125.42 | $219.49 | $438.98 | $877.95 |
| 680-719 | $163.77 | $286.60 | $573.19 | $1,146.38 |
| 660-679 | $209.74 | $367.05 | $734.10 | $1,468.20 |
| 640-659 | $257.67 | $450.92 | $901.84 | $1,803.68 |
| 620-639 | $321.64 | $562.88 | $1,125.75 | $2,251.51 |
| 580-619 | $492.01 | $861.01 | $1,722.02 | $3,444.05 |
| 560-579 | $668.28 | $1,169.49 | $2,338.97 | $4,677.95 |
| Less than 560 | $796.74 | $1,394.29 | $2,788.58 | $5,577.16 |
To determine if the buydown is worth it, calculate your break-even point by dividing the $18,503.28 in total annual savings from years one through three by the $12,750 in loan costs, which equals 1.45 — or almost one-and-a-half years. If you plan to stay in the home for at least that long, the buydown makes sense.
Mortgage buydown pros and cons
| Pros | Cons |
|---|---|
| You’ll save money on your monthly payment | Your total closing costs will be higher |
| You’ll pay less interest over the life of your loan | Your interest rate and monthly payment could increase |
| You may be able to write off the buydown mortgage costs on your taxes | You could lose your home to foreclosure if you can’t make the higher payment |
| You’ll qualify for a higher loan amount because your interest rate is lower | You’ll deplete cash savings to cover the buydown mortgage expense |
Is a mortgage buydown right for you?
A mortgage buydown can be a great way to make homeownership more affordable, especially if interest rates are high. One of the main benefits is the ability to lower your monthly mortgage payment, freeing up cash for your everyday living expenses and financial goals.
Mortgage buydowns may not make sense if you don’t plan on staying in the home long term, since it can take several years to recoup your initial investment. If you get a mortgage buydown, be prepared for your monthly payments to increase after the buydown period ends (typically after one to three years).
Determine what mortgage amount works for your budget with our home affordability calculator.
Mortgage buydown alternatives
→ Adjustable-rate mortgage. Like a mortgage buydown, an adjustable-rate mortgage (ARM) starts off with a lower, fixed interest rate that increases after a set number of years. The lower rate is known as the “teaser” rate and typically lasts three, five or seven years. Homebuyers must be ready to handle a higher monthly payment once the teaser rate expires. ARM loans can be a good option if you plan on selling or refinancing your home before the higher rate kicks in.
→ Refinancing. If you buy a home when interest rates are high, you may want to explore refinance options when rates come down. Refinancing your mortgage can be a good alternative if you can’t afford the upfront costs of a mortgage buydown, but still want a lower interest rate. Refinancing into a loan with a lower rate can also help you save money in interest over the life of your loan.
Ready to compare refinance offers? Get Your Best Rates from Top Lenders TodayFrequently asked questions
Yes, you may be able to refinance your 2-1 buydown loan if you meet the lender’s refinance requirements. Refinancing might be worth considering if you can secure a lower rate or want to tap your home equity. Just be sure to factor in closing costs to determine whether it’s worth it for you.
Borrowers can typically choose buydown plans with rates up to 3% lower than current mortgage rates. For example, if market rates are 6%, a 2-1 buydown would allow you to make payments with an initial 4% rate for the first year.
A seller may offer a mortgage buydown to make their property more appealing to potential buyers and sell their home faster. By reducing the buyer’s interest rate, the seller can lower the buyer’s monthly payment without lowering the asking price, which benefits both parties. This strategy is particularly helpful in competitive markets, or for builders who want to fill new construction homes.