The Benefits of Buydown Interest Rate

Home investment is one of the most significant decisions you will make in your life. The reason being it is a massive investment. And it is not only the home purchase cost. Home buying moves with a number of additional upfront expenses like closing costs, along with interest rates on your monthly mortgage.

Wouldn't it be good if you had the flexibility to decrease the interest rate by paying extra upfront? You no longer have to think about it because that is what you get with the buydown interest rate.

What Does Buydown Interest Rate Mean?

Think of a buydown interest rate as a way to pay less monthly mortgage with an additional upfront cost. The lender uses the higher upfront cost to make up for the discount offered through interest rate deduction.

As hard as it must be to believe, oftentimes, the upfront payments do not come from the loan borrower. The sellers contribute by providing funds in the escrow account so the lender can lower the interest rate on the loan.

But remember this generosity by the seller might also make them increase the home purchase price.

Types of Buydown Interest Rates?

Generally, there are two types of mortgage buydown that specify the terms of lowering interest rates. Let's talk about them.

Permanent Mortgage Buydown

As the name suggests, this is the mortgage buydown that carries on for the entire loan period. Having said that, there is usually a cap on the maximum interest rate you can buy down.

Temporary Mortgage Buydown

This is a more conventional mortgage interest rate buydown offered by most lenders. While the original interest rate remains the same, you may get a discount for one or more years.

The period and the discount percentages are decided according to the mortgage buydown structure you choose. We will talk about these buydown interest rate options soon.

How Does Mortgage Buydown Work?

The buydown interest rates keep your mortgage payments down for a specific period. That leads to the question which you would want to ask, "What will be the period I enjoy a subsidized interest rate?"

Well, as we touched upon earlier, that depends on which buydown structure you go for. These structures usually have two or three numbers. Here are some of the common interest rate buydown examples to help you understand how they work.

1-0 Temporary Mortgage Buydown

This structure is probably the simplest one to understand. The interest rate on your monthly mortgage is decreased by 1% for the 1st year.

Once the one year is done, the interest rate resets to the original one.

3-2-1 Temporary Mortgage Buydown

Don't get confused by the additional number you are seeing because it is exactly like the first structure. The three numbers tell us that we can benefit from the decreased interest rate for 3 years, with varying interest rates.

For the 1st year, the interest rate will decrease by 3%, followed by a 2% decrease in the 2nd year. The 3rd year is the last year for the lowered interest rate, which will be decreased by 1%.

Too much information to take in? Here is an example for you.

You have borrowed a $500,000 loan at an interest rate of 10%. The total loan period is 25 years. Here is what your interest rates will look like.

• 7% for year 1
• 8% for year 2
• 9% for year 3
• 10% for year 4 to year 25

Why Are Buydown Interest Rates Important?

While you are reading this, there might be a question bothering you, "What does the seller have to gain by reducing your interest rate and making your mortgage more affordable?"

Well, it is not just the home seller. In some cases, even the builders collaborate with the lender and add money to your escrow account to the buydown interest rate.

Let's talk about some situations where a buyout interest rate can work.

Sellers Cannot Find a Homebuyer

There are times when the sellers need to vacate their homes very soon. The reasons may include that they have an adjustable mortgage rate and will have to relocate before the interest increases. Or if the home maintenance expenses are getting too much to bear.

That might force the seller's hand to think outside the box and use this way to attract homebuyers.

Builder Buyers to Purchase the Newly Build Properties

The buydown interest rate can also be used as an incentive and a marketing tactic for real estate investors to buy newly built properties.

This mortgage buydown can give them a competitive advantage over other housing communities and attract more willing homebuyers.

Pros and Cons of Buydown Interest Rates

We have so far talked about how to buy out interest rates for reduced mortgage payments. Now it is time to discuss some of the advantages and downsides of buydown interest rates.

Advantages of Buydown Interest Rates

Save Money

In the initial period when the interest rates are low, you can benefit by making less expensive mortgage payments than you are required to.

You can save money for rainy days. We suggest either using the savings for home improvements or for when the buydown period ends and interest rates rise again.

Pay Less

You will ultimately pay less, as compared to your property agreement. That is because the upfront cost for the discounted interest rate will be paid by the builders or seller.

Fixed Payments

The interest rate during the initial period will remain the same, no matter how unstable the real estate market becomes. This makes it easier to budget for your mortgage payments.

Disadvantages of Buydown Interest Rates

Higher Total Cost

Once the mortgage buydown period ends, your interest rate might significantly rise, as you can avail of the buydown option only once. This might impact your mortgage affordability and lead to potential home foreclosure.

Hard to Find Lenders

There are not many lenders willing to have so many people in the property negotiation process. So, you will have to put on the magnifying glasses to find the lenders offering a buydown interest rate option.

Too Complex to Understand

As it can get complicated for the lender, this might also be tough for you to keep up. You will have the seller and lender or the builder and lender involved in the process. This can lead to miss understanding and a lack of communication.

What's next?

This is how you lower your interest rates and decrease your home purchase cost. If this option is one you like, now you need to find a desirable property to invest in. You can do that by visiting HAR, a reputable real estate that makes home buying easier.