Can You Buy Down an FHA Loan Interest Rate?

Federal Housing Administration (FHA) loans offer a pathway to homeownership for many individuals. It is possible to buy down an FHA loan interest rate by paying an upfront fee to secure a lower rate, which can lead to significant savings over time.

Understanding Discount Points

Buying down an interest rate involves discount points, which are fees paid to the lender at closing to reduce the loan’s interest rate. Each discount point costs 1% of the total loan amount; for example, one point on a $200,000 mortgage costs $2,000.

These points function as prepaid interest, securing a lower rate for the life of the loan. One discount point commonly lowers the interest rate by approximately 0.25%.

FHA Loan Specifics for Permanent Buydowns

FHA loans permit the use of discount points to permanently reduce the interest rate. The Department of Housing and Urban Development (HUD) outlines specific guidelines for these transactions. Discount points are a charge from the mortgage lender for the chosen interest rate and become part of the total cash required at closing.

Both the borrower and interested third parties can pay discount points on an FHA loan. This includes sellers, builders, or even family members and employers. FHA regulations generally allow interested parties to contribute up to 6% of the sales price toward the borrower’s origination fees, other closing costs, and discount points. While there are no strict FHA limits on the number of discount points a borrower can purchase, these points are included in the overall closing costs, which can range from 2% to 5% of the home’s sale price.

Temporary FHA Rate Buydowns

Beyond permanent rate reductions, FHA loans also allow for temporary rate buydowns. A temporary buydown reduces the interest rate for an initial period, after which the rate gradually increases to the original note rate. This arrangement provides borrowers with lower monthly payments during the early years of the mortgage.

The funds for a temporary buydown are typically held in an escrow account, with portions released each month to cover the difference between the temporarily reduced payment and the actual principal and interest payment. Common structures include a “2-1 buydown,” where the rate is 2% lower in the first year and 1% lower in the second year before reverting to the permanent rate in the third year. Other options, such as a “3-2-1 buydown,” may also be available, offering reduced rates for the first three years. Sellers or builders often pay for these temporary buydowns as an incentive to buyers, and while the borrower benefits from lower initial payments, they must still qualify for the loan at the full, permanent interest rate.

Evaluating a Rate Buydown

Deciding whether a rate buydown is a suitable financial move requires careful evaluation, considering both permanent and temporary options. For a permanent buydown, it is helpful to calculate the “breakeven point.” This involves dividing the upfront cost of the discount points by the monthly savings achieved from the lower interest rate, which reveals how long it will take for the savings to offset the initial expense. If a borrower plans to sell or refinance their home before reaching this breakeven point, the financial benefit of paying points may not materialize.

For temporary buydowns, the assessment centers on the benefit of reduced initial payments versus the eventual increase to the full note rate. Borrowers should ensure they can comfortably afford the higher payments once the buydown period ends. Considering the opportunity cost of funds used for points is also important; this money could potentially be used for other purposes, such as an emergency fund, a larger down payment, or other investments. Understanding these financial implications helps borrowers make an informed decision aligned with their long-term housing and financial goals.