A single percentage point increase in mortgage rates can mean hundreds more in monthly payments and potentially hundreds of thousands more over the life of the loan. With today’s high rates, you should at least consider buying down your rate or negotiating with the seller or builder to cover the cost.
In 2024, mortgage rates are hovering around 7% , making homeownership less affordable than ever, given current market prices. Many buyers, myself included before this year, believe the only two options are to either bite the bullet and hope for lower rates to refinance later or wait it out until rates drop. But there’s another option worth considering, a mortgage rate buydown.
A mortgage rate buydown allows home buyers to either permanently lower their mortgage interest rate, or temporarily lower it for the first few years, in exchange for an upfront cost. This cost is often covered by the seller or builder as an incentive to close the deal, but buyers can also choose to pay for it themselves.
My advice is to look at new developments to see if builders are offering buydown incentives to sell homes quickly. This is what my wife and I did this past March! We purchased a new build and the builder paid for our 3-2-1 mortgage buydown.
While it’s possible to permanently reduce rates by purchasing discount points, this option tends to be more expensive. Instead, let’s focus on the three most common types of temporary buydowns:
- 3-2-1 buydown: Mortgage rate is reduced by 3% for the first year. It will then increase by 1% per year for the next three years. You start paying the “final” interest rate in the fourth year.
- 2-1 buydown: Mortgage rate is reduced by 2% in the first year and then increases by 1% per year for the next two years. You start paying the “final” interest rate in the third year.
- 1-1 buydown: Mortgage rate is reduced by 1% in the first year and increased by 1% in the second year. You’ll start paying the full interest rate in the second year.
Example:
You’re purchasing a new build home with a 30-year mortgage of $500,000 at a 7.5% interest rate, resulting in monthly principal and interest payments of $3,496. To make the deal more appealing and sell the home quickly, the builder is offering to pay for a 3-2-1 rate buydown.
- Year 1: Your interest rate drops to 4.5%, and your monthly payment is reduced to $2,533.
- Year 2: The interest rate increases to 5.5%, and your monthly payment is $2,839.
- Year 3: The interest rate rises to 6.5%, and your monthly payment reaches $3,160.
- Years 4-30: For the remainder of the loan, the interest rate returns to 7.5%, and you pay the original monthly amount of $3,496.
Here’s a breakdown comparing the payments and savings for principal and interest for the 30 year fixed rate and the 3-2-1 buydown:
When to Pursue a Buydown:
- High Mortgage Rates: If current mortgage rates are high and aren’t expected to come down in the near future.
- Long-term Ownership: If you plan to own your home for several years, the upfront costs of a buydown can be justified by the long-term savings. If you’re covering the buydown cost yourself, calculate how long you would need to own the home to at least break even, meaning that the total savings from reduced monthly payments matches or exceeds the upfront cost.
- Financial Stability: Ensure that you’ll be able to afford the higher payments after the buydown period ends.
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By Phillip Kashin
Phillip Kashin is a dedicated Paraplanner, bringing genuine enthusiasm to the team at Bartley Financial. As a Candidate for CFP® Certification, Phillip is committed to continually enhancing his skills and knowledge to serve our clients better.
