Higher mortgage rates impact affordability by increasing buyers’ monthly payments. Spiking rates are particularly frustrating for buyers ready to purchase their first home and those who want to move up to larger, custom-built homes. With a 30-year mortgage, a change of even one percentage point can cost thousands of dollars — or save thousands, depending on the direction of the change.
When you apply for a mortgage, the lender will determine the interest rate on your loan. This rate is determined by multiple factors, including your credit score, the loan amount and the current mortgage market. Many people believe that the rate their lender offers is the interest rate they must accept, but there are ways to influence your rate and, therefore, manage your payment. Multiple techniques can be used to readjust a rate — especially in the early years of the mortgage loan.
One option to consider is a mortgage rate buydown. Essentially, you can secure a lower interest rate for a set amount of time with an upfront payment. In this blog, we will look at how a buydown on a mortgage rate works, who can buy down a mortgage and how buydowns may be structured for existing and custom-built homes.
Buying Down Interest Rates
A buydown is a method a borrower can use to secure a lower interest rate (and a lower monthly payment) by paying discount points at closing. The lower interest rate can extend for the entire life of the mortgage or a shorter length of time.
How Does a Mortgage Buydown Work?
A permanent mortgage buydown allows a party to buy discount points, also known as mortgage points, as a one-time upfront payment that lowers the interest rate for the entire loan term. So long as the borrower is applying for a fixed-rate mortgage, the lower rate and corresponding monthly payment will not increase during the life of the loan.
A second method of buydown, a temporary mortgage rate buydown, uses points to lower the interest rate for a set period of time in the early years of the loan. Typically, the seller (or whoever is buying down the loan) places funds in escrow, allowing the buyer to enjoy a more affordable monthly payment during the buydown period. The lender draws from the account every month to make up the difference between the full loan payment and the discounted payment. The federal government restricts temporary buydowns to a maximum of three years.
With mortgage rates expected to continue on an upward trajectory in 2022, the buydown technique can be an effective way to guard against rate increases.
Who Can Do a Mortgage Buydown?
Either a lender, seller or buyer can initiate a mortgage buydown, and terms vary from lender to lender. Not everyone who qualifies for a mortgage will qualify for a buydown. Whether a buydown mortgage is right for you depends on your financial situation and whether it will ultimately save you money.
In the case of a party buying down a rate on behalf of the buyer, this is done to increase the chance of selling the property by making it more affordable and allowing the buyer to qualify for the mortgage more easily. The seller of the property typically places funds in an escrow account to be paid out to the lender during the first years of the loan, making the buyer’s monthly payment more affordable.
How Much Does a Mortgage Buydown Cost?
The cost of a mortgage point varies, based on the size of a mortgage loan. Because one point represents one percent of the cost, on a $500,000 mortgage, one point would equal $5,000, two points would equal $10,000 and so on. Each point reduces the mortgage rate by 0.25 percent. If you are presented a 6 percent interest rate on a $500,000 loan, you can pay one point ($5,000) in exchange for a 5.75 percent interest rate. You can buy down your interest rate by up to 1 percent to reduce total interest paid and enjoy a lower payment. There are also various fees associated with a buydown. Ultimately, the cost of the buydown will be set by the lender.
With a temporary buydown, the buyer’s savings will equal the upfront cost by the end of the buydown period.
Structuring a Temporary Mortgage Buydown
Two of the most popular types of temporary mortgage buydowns are the 3-2-1 and the 2-1 structure. With a 3-2-1 buydown, the buydown period lasts three years and enables the buyer to pay less interest after receiving the loan due to the points paid upfront. The interest rate is reduced for three percentage points the first year, two percentage points the second year and one percentage point the third year. On a mortgage with a 6 percent interest rate, the interest rate would be reduced to 3 percent in the first year, 4 percent in the second year and 5 percent in the third year. For the remaining years, the interest rate would rise to the full rate.
A 2-1 buydown reduces the interest rate for two percentage points the first year and one percentage point the second year. On a mortgage with a 6 percent interest rate, the interest rate would be reduced to 4 percent in the first year, then to 5 percent in the second year. For the remaining years, the interest rate would rise to the full rate.
If you opt for a temporary mortgage buydown, be sure you can afford the mortgage at the higher interest rate at the end of the buydown. However, if at that time interest rates have dropped and your credit is good, it may be beneficial to refinance the mortgage loan at a better rate.
When Does a Rate Buydown Make Sense?
There are a number of scenarios where a temporary buydown can prove beneficial:
- If a buyer’s future income is expected to increase before the buydown ends, making the higher payment affordable.
- When there are short-term financial obligations the buyer will soon pay off and eliminate, such as a loan or the cost of moving and furnishing a new home.
- When mortgage interest rates are high but are projected to decrease in the future, providing the opportunity for a potential refinance.
Take Advantage of Our Current Incentives on Custom-Built Homes
Gateway Construction, LLC is currently offering great builder incentives of up to $50,000 on select custom-built homes under construction! Buyers can choose a price reduction or a 2-1 mortgage rate buydown, whichever is most beneficial for their situation. To learn more about available incentives and speak with a realtor, give us a call at (307) 632-8950 or submit our online contact form. To find out what’s happening at Gateway, follow us on our social media platforms, including Facebook, Instagram, Twitter and LinkedIn.