The market has cooled, and mortgage interest rates are up, but don’t lose faith! There are many options out there to help benefit buyers and sellers struggling in the current market conditions. A popular financial strategy is mortgage interest rate buydowns. Mortgage interest rate buydowns allow home buyers to reduce their monthly mortgage payments during the first few years of homeownership and can benefit both buyers and sellers.
What is a Mortgage Interest Rate Buydown?
An interest rate buydown is when a homebuyer provides an additional fee upfront for a lower interest rate on their mortgage loan. This fee is usually paid by the seller as a way to make their home more attractive to potential buyers. While the seller typically pays for the buydown, the cost can be included in the purchase price or negotiated as part of the overall terms of the sale.
The buydown is a type of prepaid interest and can be structured in multiple ways. A typical buydown type is a 2-1 buydown, in which the interest rate is reduced by 2% in the first year of the loan and by 1% in the second year. Another form is a 3-2-1 buydown, which reduces the interest rate by 3% in the first year, 2% in the second year, and 1% in the third year.
How Does a Mortgage Interest Rate Buydown Work?
Suppose a homebuyer is purchasing a $400,000 home and taking out a 30-year fixed-rate mortgage with an interest rate of 6%. The seller offers to pay for a 2-1 buydown, which would reduce the interest rate to 4% in the first year and 5% in the second year.
Under this scenario, the buyer would pay an upfront fee to the lender, which is used to reduce the interest rate in the first two years. The fee could be a percentage of the loan amount, such as 2% of $400,000 or $8,000. The seller would pay this fee as part of the closing costs.
During the first year of the loan, the buyer’s monthly payment would be based on the reduced interest rate of 4%. This payment would increase in the second year with an interest rate of 5%. After the second year, the interest rate would return to the original rate of 6%, and the buyer’s monthly payment would increase accordingly.
Mortgage interest rate buydowns can be a valuable financial strategy for homebuyers and sellers. Buyers can benefit from lower monthly payments and increased affordability by reducing the interest rate on a mortgage loan during the first few years of homeownership. While sellers can benefit by making their home more attractive to buyers and increasing their chances of a successful sale. If you’re considering buying or selling a home, be sure to discuss the option of a mortgage interest rate buydown with your lender and realtor. Need help finding a lender? Check out our Home Buying Guide for a list of our favorites.