How Much Does a Rate Buydown Cost?

A mortgage rate buydown is a financial strategy allowing a borrower to secure a lower interest rate on their home loan by paying an upfront fee. This technique aims to reduce monthly mortgage payments and the total interest paid over a specified period or the entire loan term.

Understanding Rate Buydowns

A rate buydown involves paying “points” to the lender, which are essentially prepaid interest. Each point typically equates to 1% of the total loan amount. For example, on a $300,000 mortgage, one point would cost $3,000. These points are used to reduce the interest rate the lender charges, leading to a lower monthly mortgage payment.

Calculating Permanent Rate Buydown Costs

Permanent buydowns involve paying points to secure a lower interest rate for the entire duration of the loan. The cost is calculated as a percentage of the total loan amount, where each point is 1%. For instance, if a loan is $400,000, one point would cost $4,000. This upfront payment directly reduces the interest rate applied to the loan for its full term.

Several factors influence the total cost of a permanent buydown. A larger loan amount will result in a higher cost for the same number of points. The desired reduction in the interest rate also plays a role; a greater rate reduction typically requires purchasing more points. Current market interest rates and the specific pricing structures of individual lenders also affect the cost, as lenders offer a menu of interest rates tied to different point costs. Typically, one discount point might reduce the interest rate by approximately 0.25% for the life of the loan, though this can vary by lender.

Calculating Temporary Rate Buydown Costs

Temporary buydowns are distinct in their cost structure, as they provide a reduced interest rate for a set period, such as the first one, two, or three years of the loan. Common structures include a 2-1 buydown, where the rate is reduced by 2% in the first year and 1% in the second year, or a 3-2-1 buydown, which offers reductions for three years. After this initial period, the interest rate reverts to the original, higher rate agreed upon at the time of closing.

The cost of a temporary buydown is the sum of the interest savings over the buydown period. This is calculated by determining the difference between the monthly interest payment at the original rate and the reduced monthly interest payment at the buydown rate for each month of the temporary period. This total cost is typically paid upfront at closing and held in an escrow account. Funds are then drawn from this account each month to subsidize the borrower’s payments, making up the difference between the lower payment and the actual interest due to the lender. For example, a 2-1 buydown on a $200,000 mortgage with a 5% prevailing rate might have rates of 3% in the first year and 4% in the second, with the cost being the accumulated monthly savings.

Who Pays for a Rate Buydown

While a rate buydown is applied to the borrower’s mortgage, the upfront cost can be covered by various parties. The most direct scenario involves the homebuyer, or borrower, paying the points out of pocket at the time of closing. This cost is then included as part of their closing expenses.

Alternatively, the seller of the property might pay for the buydown as a concession to make the home more attractive to prospective buyers. In new construction, it is common for the builder to offer to pay for a rate buydown as an incentive to sell their homes. Regardless of who covers the cost, the payment for the buydown will be reflected in the closing statement or sales contract for transparency.