The What, Why and When of Mortgage Interest Rate Buy Downs

By Douglas Katz – 02/09/23
With rates still up from the record lows and affordability still impacting a lot of buyers, buy downs are all the rage right now.  I am getting asked every which way whether I offer them and whether they make sense.  There is a lot to know and I want to demystify if I can what a buy down is, when to use it and how to calculate whether it makes cost effective sense.
What are mortgage rate buy downs?
A mortgage rate buydown is a financing technique in which a borrower pays an upfront fee in exchange for a lower interest rate on their mortgage loan. The fee, known as “buydown points,” is paid directly to the lender in exchange for a lower interest rate, which can lower the monthly mortgage payment. The buydown points effectively buy down the mortgage rate for a specified period, usually the first few years of the loan. After the specified period, the interest rate will adjust to the market rate.

Mortgage rate buydowns can be useful for borrowers who need to lower their monthly mortgage payment in the short term, for example, if they are starting a business or need to free up cash for other expenses. However, it’s important to keep in mind that the upfront cost of the buydown points must be weighed against the long-term savings from the lower mortgage rate, as well as the length of time the lower rate will be in effect.

When should i use a mortgage rate buydown?
Whether or not a mortgage rate buydown is a good option for you will depend on your specific financial situation and goals. Here are a few scenarios when a mortgage rate buydown may make sense:
  1. Short-term savings: If you need to lower your monthly mortgage payment in the short term, a mortgage rate buydown can be a good option. This can help free up cash flow for other expenses, such as starting a business, paying off debt, or saving for a down payment on another property.
  2. Affordability: If you are having trouble affording a home at current interest rates, a mortgage rate buydown can help lower your monthly payment and make home ownership more affordable.
  3. Future rate uncertainty: If you expect interest rates to rise in the near future, a mortgage rate buydown can help lock in a lower rate for a specified period of time, potentially saving you money in the long run.

However, it’s important to keep in mind that there is a cost associated with a mortgage rate buydown in the form of buydown points. You should carefully consider the upfront cost of the buydown points and weigh it against the long-term savings from the lower mortgage rate, as well as the length of time the lower rate will be in effect. It’s also a good idea to consult with a financial advisor or mortgage professional to help determine if a mortgage rate buydown is right for you.

How do I calculate whether a buy down is worth the cost?
To determine if a mortgage rate buydown is worth the cost, you can use the following steps:
  1. Calculate the monthly payment with the lower interest rate: First, calculate the monthly mortgage payment for the loan with the lower interest rate after the buydown.
  2. Calculate the monthly payment without the buydown: Next, calculate the monthly mortgage payment for the same loan without the buydown, at the higher interest rate.
  3. Compare the two payments: Subtract the monthly payment without the buydown from the monthly payment with the lower interest rate to determine the monthly savings from the buydown.
  4. Determine the break-even point: Divide the cost of the buydown points by the monthly savings to determine the number of months it will take to break even on the cost of the buydown. This is the point at which the savings from the lower monthly payment will equal the cost of the buydown points.
  5. Consider your time horizon: Consider the length of time you plan to keep the loan, as well as the length of time the lower interest rate will be in effect. If the break-even point is sooner than the length of time you plan to keep the loan, the buydown may not be worth the cost. On the other hand, if the break-even point is later than the length of time you plan to keep the loan, the buydown may be a good option.

It’s important to keep in mind that these calculations are based on a number of assumptions, including the length of time you plan to keep the loan, the length of time the lower interest rate will be in effect, and the amount of the buydown points. Additionally, you should take into account any other factors that may impact your financial situation, such as changes in your income, interest rates, and property values. For a more accurate and personalized analysis, it’s a good idea to consult with a financial advisor or mortgage professional.