What it means
Mortgage lenders price a loan using an interest rate. A buydown lets someone pay an extra fee at closing in order to receive a lower rate.
The fee is often expressed in points, where one point equals 1% of the loan amount. There are two main kinds.
A permanent buydown lowers the rate for the entire life of the loan, usually in return for paying points. A temporary buydown lowers the rate for the first one to three years and then the rate returns to the full level.
A common temporary structure is the 2-1 buydown. The borrower pays a rate that is 2 percentage points below the note rate in year one, and 1 point below in year two, and then the full rate from year three.
The cost is held in an account and used to top up the lender's payments during the reduced period. Who pays varies.
A home builder may fund a buydown to help sell new houses without cutting the price, and a seller may offer one as a concession. A buyer may pay points to reduce the long-term cost.
The key calculation is the break-even point, which is the number of months before the monthly saving repays the upfront cost. A buyer who plans to sell or refinance before that point loses money by buying down the rate.
Anyone considering a buydown should compare it with simply paying down the loan with the same cash. Lenders and regulators require the costs to be disclosed, and tax treatment of points differs by country and circumstance.
Borrowers should ask for the full figures in writing before committing.
In practice
Real-world examples.
Example
A home builder is struggling to sell new houses in a market with high mortgage rates. It offers a 2-1 buydown paid from its own funds. Buyers enjoy lower payments in the first two years, and the builder avoids cutting list prices. The builder records the cost as a reduction of the sale price in its accounts.
Example
A buyer plans to stay in her home for at least fifteen years and has spare cash. She pays two points to lower her rate permanently. After the break-even point of about five years, every additional month is a saving. Her adviser reminds her that she gives up the use of that cash in the meantime.
Example
A seller agrees to pay $6,000 towards the buyer's closing costs. The buyer asks to use the money to buy down the rate instead. The buyer's monthly payment falls, but the seller's cost is unchanged.
Formula
Calculation
Break-even months = Upfront buydown cost / Monthly payment saving
Suppose a buyer takes a $300,000 30-year mortgage at 6.50%, and pays one point, which is 300,000 x 0.01 = $3,000, to reduce the rate to 6.25%. These rates are assumed for illustration.
The monthly payment at 6.50% is $1,896.20 and at 6.25% it is $1,847.15, so the saving is 1,896.20 - 1,847.15 = $49.05 a month.
Break-even = 3,000 / 49.05 = about 61 months, or just over five years. If the buyer keeps the loan longer than that, the buydown pays off.Case study
Seen in the real world.
Larkspur Homes is a fictional developer with 40 unsold townhouses. Rather than cut prices by 5%, which would reduce its margin and could upset earlier buyers, it offers a funded 2-1 buydown on every sale. The cost is about $7,500 per home.
Buyers respond well, because their payments are lower in the first two years when household budgets are tightest. In the illustrative quarter that follows, the company sells 25 of the homes, and the finance director compares the buydown cost against the price cut it would otherwise have given.
The comparison shows that the buydown costs less than the discount and keeps the listed price intact. However, she also notes that some buyers may struggle when payments step up in year three, so the sales team is asked to explain the full payment schedule clearly. The company also gives each buyer a written table of payments for the first three years, so nobody is surprised when the rate steps up.
Watch out
Common mistakes.
- Assuming the lower rate lasts forever. A temporary buydown ends after a set period and payments then rise to the full rate.
- Ignoring the break-even point. If you move or refinance early, the upfront cost may never be recovered.
- Thinking a seller-paid buydown is free for the buyer. The seller may build the cost into the price, so the buyer should compare the total deal.
Questions
People also ask.
What is a point?
One point is 1% of the loan amount, paid upfront to lower the interest rate. On a $300,000 loan, one point costs $3,000.
Is a buydown better than a lower price?
It depends on how long you keep the loan and what the cash could do elsewhere, so compare both options in numbers.
Who can pay for a buydown?
The buyer, the seller or the builder can pay, depending on the lender's rules and the deal. Limits often apply to the size of seller contributions.
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