Interest Rate Buydowns

Interest Rate Buydown Definition

A buydown is an option that lets mortgage borrowers obtain a lower interest rate over the first few years or possibly the entire life of the loan. Sometimes buydowns feature points that a homebuyer can purchase against the mortgage.

What is a Temporary Interest Rate Buydown?

A temporary buydown initially offers a lower interest rate and lower monthly payments. To reduce monthly payments during the first years, borrowers make an initial lump sum payment or agree to a higher interest rate. Over the years, the interest rate gradually increases until it peaks at a fixed rate. Borrowers who chose this loan often expect a significant increase in their income.

Permanent Buydowns

Interest rates move each business day and sometimes more than once.

The interest rate a particular consumer “gets” is a function of a number of variables, such as loan structure type, down payment, credit score, loan amount, points, closing costs, and more.

The going interest rate on any given day which involves no points is generally referred to as the “par rate.” A consumer has a choice to select the par rate, or they may consider an interest rate buydown. There are temporary rate buydowns and there are permanent rate buydowns.

A permanent interest rate buydown is where the consumer selects a lower rate than the going par rate.

There is a cost for this lower rate, in the form of a one-time fee referred to as “Discount Points.” Buy paying discount points, the consumer may select a lower rate that will remain in effect for the full term of their loan. The amount of this fee (Discount Points) varies, based on several factors. The Discount Points are multiplied times the Loan Amount to come up with the one-time fee.

One example (based on one set of variables) might be a cost of 0.7% Discount Point (one-time fee) to buy the rate down by 0.125% (permanent reduction to the interest rate).

So, on a $200,000 loan amount x 0.70% Discount Point =$1400.00 one-time fee to get an interest rate that is 0.125% lower than that day’s “par rate.” This 0.125% rate reduction on a loan of $200,000 would result in a lower monthly payment of roughly $15/month.

You can see that this is an expensive cost for a nominal benefit.

An Interest Rate Buydown on a FHA Loan

Temporary interest rate buydowns are not permitted for FHA borrowers if they are refinancing their home or if they're getting an ARM loan. However, permanent buydowns are allowed.

Please contact a Residential Mortgage Loan Originator if you have any questions.

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