Understanding How to Buy Down Interest Rate
Homebuyer Buydowns
A buydown is when a homebuyer pays extra money upfront to lower the interest rate of their mortgage. This could reduce monthly payments by thousands of dollars over the life of a 30-year loan.
The cost of a buydown can vary from lender to lender. It’s important to do the math before you make any commitments, whether you pay for it yourself or ask the seller to cover it.
Temporary Buydowns
A temporary buydown allows borrowers to lower their mortgage payment by paying a lump sum of cash during the early years of their loan. These buydowns are offered by some lenders, builders and sellers as a way to incentivize buyers to purchase their homes.
These types of programs allow homebuyers to pay a reduced rate in exchange for a lump sum of cash that the lender, builder or seller puts into an escrow account at closing. When the funds are depleted, the borrower’s mortgage payment is calculated using a full interest rate and payments resume normal for the remainder of the loan term.
Temporary buydowns are available on new construction and existing homes purchases for primary residences, allowing homebuyers to save money up front and spend it on future improvements. They also provide a sense of security for buyers who are worried about their mortgage payment rising to the point they cannot afford it.
Many of these buydowns last three years. The loan rate is reduced by two percentage points in the first year, by one percentage point in the second year and then rises back to its full interest rate in the third year. For example, Guild’s seller-paid 1-0 buydown program reduces the note rate by 1% for a year and then it’s non-reduced until year 30.
The 1-0 buydown is ideal for homebuyers who plan to have higher incomes in the near future and who want a lower interest rate in the short run to save money on their mortgage payment. They also benefit from the stability of a fixed rate once the buydown period ends.
Other types of temporary buydowns include 3-2-1 and 2-1 buydowns. A 3-2-1 buydown reduces the note rate by two percentage points in the first year and then by one percentage point each in the second and third years.
A 2-1 buydown reduces the note rate by one percentage point in the first year and then by one percentage in each of the next two years.
If you’re interested in purchasing a home in this challenging market, talk with your broker or lender to learn more about how these programs can help you get into the house you want. You’ll also need to be sure you qualify for the reduced monthly payment, so contact a mortgage specialist to help determine what is right for your situation.
Permanent Buydowns
A permanent buydown is when you pay a one-time fee to reduce your interest rate for an extended period of time, usually over the life of your mortgage. This type of buydown can make your mortgage more affordable or help you qualify for a home loan.
Unlike temporary buydowns, permanent interest rate reductions reduce your interest rate on an evenly distributed basis over the duration of your mortgage. They also allow you to accumulate savings over time.
The cost of a permanent buydown varies depending on the number of discount points you want to use. For example, a borrower who wants to use three discount points could save up to 75 basis points off prevailing market rates with the Financed Permanent Buydown Mortgage from Freddie Mac.
If you’re planning to stay in your new home for a long period of time, this option makes sense. However, if you’re moving in less than two years, this may not be an effective way to lower your interest rate.
To qualify for a permanent buydown, you need to meet certain criteria. These include having a good credit score, a steady job, a low debt-to-income ratio and a sufficient down payment on the property you plan to purchase.
For example, a buyer with an income of $40,000 and a 10% down payment could qualify for a $250,000 mortgage at 4% interest. Using three discount points would drop the interest rate on this loan to 3.75%.
Another benefit of permanent buydowns is that they allow borrowers to build equity more quickly, which can be useful if you’re planning on selling your home in the future.
Oftentimes, builders will offer to buy down a buyer’s mortgage interest rate as part of seller concessions. This is a great way to help buyers get approved for a mortgage and ease them into homeownership.
In addition, builders often offer to deposit the money into an escrow account and use it to subsidize the buyer’s monthly payments during the first years of ownership. This helps the buyer ease into the financial responsibility of owning a home and is a great way for builders to increase their sales price.
Discount Points
In the process of buying a home, you may be presented with two financing options that can help reduce your costs: discount points and lender credits. Understanding the pros and cons of each can help you decide which option is right for you and your situation.
Discount points are an additional payment that can be added to your mortgage at closing. They essentially pay for prepaid interest, reducing your interest rate by a certain percentage. Typically, this is 0.25% but can vary depending on the lender, type of loan and prevailing rates.
The amount you save by purchasing points can be significant if you're looking to buy a home that has a higher than usual interest rate. This is especially true if you're struggling to qualify for the loan and have the cash on hand to purchase one or more points.
This can make your monthly mortgage payment a lot more affordable. However, it's important to keep in mind that discount points take time to recoup their initial costs. Generally, it takes 20 months or more for your savings to exceed the cost of paying for discount points.
Another consideration is how long you plan to stay in your new home. If you're planning to move out in a few years, it might be better to focus on other ways to lower your mortgage costs.
For example, applying extra cash to your down payment can be a more effective way to avoid mortgage insurance. Also, your credit score will likely improve if you have a larger down payment.
You can also use points to bring your down payment up to the 20% threshold that eliminates the need for mortgage insurance. This can help you qualify for a large mortgage.
It's always a good idea to consult with a financial expert to find out how much you can afford for your down payment, and if paying for discount points makes sense for you. These points may be deductible on your taxes, too.
Breakeven Period
A breakeven period is the amount of time it takes for a business to generate enough revenue to cover its fixed costs and earn a profit. It is a common tool for business leaders to use when making important decisions. This analysis can help a company find missing expenses, limit decisions based on emotions, establish goals, secure funding, and set appropriate prices for its products.
A business’s breakeven point can be calculated by dividing the total fixed costs of the company by the contribution margin, which is the unit sale price minus variable costs. For example, if a company has $1 million in fixed costs and a 37% gross margin, its breakeven point would be $2.7 million ($1 million / 0.37).
The company's breakeven point can also be calculated by the volume of units needed to sell to cover all its costs. If the company had 100,000 units and a 30% contribution margin, its breakeven point would be $1,300,000.
Companies can calculate their breakeven points through ERP and accounting software with managerial accounting features. The breakeven point can also be found in a company’s financial statements.
Similarly, in trading options, the breakeven point is the market price that an option buyer must reach to avoid losing money. The price must be higher than the strike price to avoid a loss, and lower than the premium paid to avoid a profit.
In addition, the breakeven point can be used to calculate the time it will take for an investment or project to recoup its initial outlay. For instance, if a company invested $100 in a startup, its payback period would be the number of accounting periods it took to repay that initial investment with net income.
The same can be said of a mortgage loan. Buying down the interest rate will generally save you more than the cost of the discount points, and will be worth the upfront investment if you plan to stay in your home for a long time. However, if you are planning to refinance or move within the next few years, your savings may not be worth the cost of the buydown.
