Buy-Down Interest Rate: Is It Worth It?

Summary

A buy-down rate is a mortgage financing tool to reduce your interest rate. While it can be an excellent investment when rates are steep, it is not always a good idea. The key factor that determines whether or not buying down your interest rate is a good financial decision is how long you plan to own your home.

The early 2020s have seen mortgage rates rise sky-high, making many prospective homebuyers reluctant to buy homes while homeowners face challenges in selling. As of 2023, mortgage rates hover just over 6%, almost double the mortgage interest rate from the previous year.

Mortgage rate buydowns offer a way to lower a buyer’s monthly mortgage payments on a new home. By offering more money upfront, you can get a lower interest rate to make your mortgage more affordable in the long run.

Let’s take a closer look at how a mortgage rate buydown works to help you decide if it’s the right option for you.

Mortgage buydown explained 

A mortgage rate buydown allows you to pay a lump sum upfront to lower your interest rate and reduce your monthly mortgage payments, either temporarily or throughout the life of your home loan.

A buyer’s interest rate is typically determined based on the market as well as their credit history, so fluctuating mortgage market conditions can make it challenging for some people to buy a home. The purpose of a mortgage buydown is to encourage buyers to buy a home by offsetting the impact of inflation when interest rates are high.

While it is a common practice, not all financial institutions will offer a mortgage buydown program. Additionally, the terms of a mortgage buydown will vary by mortgage lender.

How does a buydown mortgage work?

With a buydown mortgage, shoppers can purchase discount points in exchange for a lower interest rate, which reduces the buyer’s monthly mortgage payment. Note that paying discount points on a mortgage usually means your closing costs will increase.

Mortgage rate buydown example

Imagine you’re a homebuyer in the process of closing on a home loan. You decide to place a down payment of $500,000 and finance the remainder of the cost with a $200,000 mortgage loan. The interest rate on your 30-year fixed-rate mortgage loan is 7%, and your monthly payment is $1,331.

If you opt for a two-point mortgage rate buydown, your interest rate will temporarily fall to 5%, which will decrease your monthly payments to $1,074. Thus, with a mortgage rate buydown, you would save over $3,000 in interest for the first year of your mortgage.

How much is a point worth on a buydown mortgage?

Every discount point a borrower pays down is worth 1% of the mortgage — for example, if the total mortgage is $200,000, one point would be worth $2,000.

How many discount points a 1% decrease in your interest rate is worth will depend on your lender’s terms. So for instance, to see a 1% decrease in your interest rate that’s worth four discount points, you would have to pay $8,000 on a $200,000 mortgage.

Why not cut the purchase price?

Sellers sometimes fund a mortgage buydown to incentivize reluctant buyers to purchase their homes. This is because mortgage buydowns are mutually beneficial for homebuyers and home sellers.

As illustrated in the table below, a $257 discount from a mortgage buydown is a more attractive deal than a $67 price reduction from a sales cut. Interest reduction won’t impact the overall purchase price, so sellers can secure a higher selling price while buyers get a more affordable interest rate in the long term.

Loan amountInterest rateMonthly payments
No concessions$200,0007%$1,331
Price reduction$190,0007%$1,264
Rate buydown$200,0005%$1,074

How mortgage buydowns are structured

Two common mortgage buydowns offered by lenders are the 3-2-1 and the 2-1 temporary buydown mortgage structures. Lenders also offer a permanent mortgage rate buydown known as an evenly distributed interest rate reduction.

3-2-1 buydown mortgage

With this temporary mortgage rate buydown, your interest rate will be 3% lower for the first year of your mortgage. In the second year, your mortgage interest rate will increase by one percentage point; in the third year, it will increase by two percentage points. By the fourth year, your lender will charge the initial interest rate before the temporary mortgage rate buydown.

YearBuy-down interest rateBuydown monthly paymentRegular interest rateRegular monthly paymentAnnual savings
14%$9557%$1,331$4,512
25%$1,0747%$1,331$3,084
36%$1,1997%$1,331$1,584
4 to 307%$1,3317%$1,331$0

2-1 buydown mortgage

The 2-1 buydown structure works similarly to the 3-2-1 structure, but instead of a 3% rate reduction in the first year, you’ll get a 2% rate reduction that lowers your monthly payment. In the second year, you’ll have a 1% rate reduction before your interest rate returns to normal in the third year.

YearBuy-down interest rateBuydown monthly paymentRegular interest rateRegular monthly paymentAnnual savings
15%$1,0747%$1,331$3,084
26%$1,1997%$1,331$1,584
3 to 307%$1,3317%$1,331$0

Evenly distributed interest rate reduction

This permanent mortgage rate buydown structure allows you to pay a larger lump sum upfront to reduce your interest rates throughout the life of the loan. Although it’s a more costly option, permanently lowering your interest rates can save you a considerable amount of money in the long term. As shown in the table below, a permanent mortgage rate buydown can save you over $3,000 per year, which amounts to almost $93,000 in savings for the life of the loan.

YearBuy-down interest rateBuydown monthly paymentRegular interest rateRegular monthly paymentAnnual savings
1 to 305%$1,0747%$1,331$3,084

Is a buydown mortgage worth it?

Opting for either a temporary or a permanent rate buydown can be a great way to save money on your mortgage. However, deciding whether this particular mortgage financing technique is the best option for you will require careful evaluation of your specific financial situation.

First and foremost, rate buydowns can be costly upfront, so confirm that you have enough funds to cover the buydown and the closing costs. Second, consider whether you intend to live in your new home long enough to break even on the cost of your buydown; a rate buydown may not make financial sense if you end up paying more upfront than you would have paid in interest over the long term.

How to calculate your buydown mortgage’s break-even point

Use the following formula to determine the break-even point of your buydown mortgage:

Break-even point = Cost of 1% interest rate reduction ∕ Monthly savings

Step 1: Calculate the cost to reduce your mortgage rate by 1%

Continuing from the previous example, you have a 30-year mortgage of $200,000 with an interest rate of 7%. If your lender charges four points to reduce your mortgage rate by 1%, that means you’ll need to buy down $8,000 of the mortgage.

Step 2: Calculate your monthly savings

Paying the buydown cost will reduce the interest rate to 6%, which will lower your monthly mortgage payments from $1,331 to $1,199. In this case, your monthly savings would be $132 per month.

Step 3: Calculate your break-even point

When you divide the $8,000 (the cost of a 1% rate buydown) by $132 (your monthly payment savings), you’ll get 60.6 months. This means it will take you about five years to recover the cost of a 1% buydown on your mortgage loan. Therefore, if you plan to live in your home for less than five years, a buydown rate may not be the best option.

Pro Tip

Use a mortgage calculator to determine how much your monthly payments will be after factoring in your loan amount and interest rate.

How to pay for a mortgage buydown

The following are a few options you can use to finance a mortgage buydown:

  • Ask the seller to pay A seller may fund a mortgage rate buydown to incentivize buyers to purchase their home.
  • Pay in cash If you’ll have some extra cash to spare after buying a home, you can use that money to buy down your interest rate. We recommend using the above break-even point formula to determine if buying down your interest rate makes financial sense.
  • Builder closing cost incentive If you opt to use the homebuilder’s lender of choice, you may receive a discount that will help you cover your buy-down rate.
  • Family and friends Though asking for help from family and friends isn’t always ideal, they may be able to help you cover the upfront cost of a mortgage buydown to lower your interest rate.

Alternatives to reduce your mortgage rates and monthly payment

If an interest rate buydown is out of your budget or otherwise not worth the cost, you can still secure an affordable mortgage rate through an adjustable-rate mortgage program or from government-backed loans.

Adjustable-rate mortgage (ARM)

An adjustable-rate mortgage is a home loan with an interest rate that varies over time. Typically, you’ll get lower introductory rates for the first three to ten years of your loan. However, be aware that because your interest rates are susceptible to market fluctuations after this initial term, you may end up paying more in the future if interest rates rise.

Government loans

Government-backed loans, such as FHA, USDA, and VA loans, are excellent options for getting a mortgage at a lower rate without paying for discount points upfront. However, you must meet specific requirements in order to qualify for one of these loans.

Federal Housing Administration (FHA) loans

FHA loans are backed by the Federal Housing Administration and help low-to-moderate-income families purchase their first homes. To qualify for this loan, you must have a minimum credit score of 500 and be able to pay a minimum mortgage down payment of 10%. While this program’s requirements are more relaxed than those of a conventional loan, you must still pay for mortgage insurance.

Department of Veterans Affairs (VA) loans

If you’re an active military member or a veteran, you may qualify for a VA loan. This loan doesn’t require a minimum credit score or down payment. Additionally, it offers some of the lowest rates to current and former military members and their families.

U.S. Department of Agriculture (USDA) loans

USDA loans assist homebuyers in qualifying rural areas. There is no down payment, but you must have a minimum credit score of 640 to qualify.

FAQ

Is it better to buy points or put more money down?

Whether you should buy discount points to reduce your interest rate or offer a larger down payment depends on how long you plan to own your home. Paying a larger down payment may mean little to no mortgage insurance payments or lower monthly payments on a reduced loan price. However, investing in mortgage discount points may mean lower monthly payments due to reduced interest.

Generally, you must own your home for some time to break even on a mortgage buydown. Therefore, a buydown mortgage may make economical sense if you plan to live in your home for several years. Conversely, a larger down payment on your home may save you more money if you plan to stay in the home for only a few years.

How many points can I buy down on a mortgage?

The number of points you can purchase will vary by financial institution. However, most lenders will only let you purchase up to four mortgage points.

Is it smart to buy down my interest rate?

Buying down your interest rate can be a great way to save money on your mortgage, provided you have sufficient funds to cover the cost of a buydown and you plan to own your home past the break-even point.

How much does it cost to buy down a mortgage discount point?

A mortgage discount point is worth 1% of your mortgage, and the number of discount points it costs to lower your interest rate by 1% will depend on the terms of your loan. For example, your lender may charge one discount point for a 0.25% reduction of your interest rate, in which case you would have to pay four discount points to decrease your interest rate by 1%.

When should I opt for a mortgage buydown?

A mortgage buydown can help you save money on your loan in the long term, especially when interest rates on the market are high. It’s worth the investment if you’re planning to stay in your home for several years and you have enough money to pay for an interest reduction.

If you can’t afford a buydown mortgage, you still have options to get a mortgage at a competitive rate, such as government-sponsored loans and adjustable-rate mortgages.

Why are buydowns popular?

Whenever housing market rates are on a steep incline, mortgage buy-down programs gain traction. Lenders will offer these loan programs to reduce interest costs, thus incentivizing more buyers to make home purchases. For example, instead of buying a home at a 6% interest rate, a buyer can lower their monthly payments by reducing their interest to 3% for a designated period of time.

Key Takeaways

  • With a mortgage buydown, a homebuyer can temporarily or permanently decrease their interest rate to reduce their monthly mortgage payments.
  • To buy down the interest rate on a mortgage, a buyer must pay upfront for a set number of discount points, each worth 1% of the total mortgage loan amount.
  • Temporary rate buydowns include the 3-2-1 and the 2-1 structures, while a permanent option is the evenly distributed interest rate reduction.
  • Whether a buydown mortgage makes financial sense depends on how long you plan to live in your new home. If the savings on interest will eventually amount to more than your upfront payment, then a mortgage rate buydown could be worth the investment.
  • If you can’t afford a mortgage rate buydown, other options to get a lower monthly payment on your mortgage include a larger down payment, an adjustable-rate mortgage, and government loans.

Buying your first home is exciting, but the process of finding the right mortgage loan can be overwhelming. If you’re not sure where to even begin your research, SuperMoney can help make your homebuying journey easier. Start by reading our first-time homebuyer guide and our expert guide on how to finance a house, then use our comparison tool to find the best mortgage lenders for your needs!

View Article Sources
  1. Mortgage rates – Freddie Mac
  2. Selling guide – Fannie Mae
  3. What are (discount) points and lender credits and how do they work? – Consumer Financial Protection Bureau
  4. Adjustable rate mortgage – The Federal Reserve Board
  5. How Long Does It Take to Sell a House? – SuperMoney
  6. What Credit Score Do You Need to Buy a House? – SuperMoney
  7. What is an Adjustable-Rate Mortgage? – SuperMoney
  8. FHA Loans: Definitive Guide to FHA Lending – SuperMoney
  9. VA Loan With 500 Credit Score: Here Are Your Options – SuperMoney
  10. Why you may want to consider a USDA loan – SuperMoney
  11. First-Time Home Buyer Guide – SuperMoney
  12. How to Finance a House – SuperMoney