When you decide to buy a home, you’re committing to not only pay the purchase price of the home, but also the mortgage interest, or the cost of borrowing money from a mortgage lender.
Although interest rates have fallen in recent months, many homebuyers are still looking for ways to make home purchases more affordable. And while it may be tempting to sit back and hope mortgage rates continue to fall, there’s no guarantee that will happen. This is where home loan interest purchase comes into play.
By paying a little more upfront, you can ensure a lower mortgage rate and keep more money in your pocket each month.
What is a mortgage buyout?
A “mortgage buydown” is a financing arrangement in which a buyer, seller, or builder pays mortgage points, also known as discount points, at closing to obtain a lower interest rate. This one-time fee is paid at closing in exchange for a lower interest rate.
There are a variety of ways to buy down a mortgage, depending on the lender and whether you want a permanent or temporary mortgage buydown rate.
Permanent and temporary acquisitions
Mortgage buydowns can be done over a fixed period of time or the life of the loan.
Permanent mortgage purchase
With this option, you purchase a lower interest rate over the life of your loan from your lender through discount points at the end of your loan. Unlike a temporary mortgage buydown, your interest rate will not increase.
temporary mortgage purchase
Under this system, mortgage interest rates are reduced for a certain period of time, after which they return to the standard amount. For example, you’ll see a temporary mortgage buydown structure called a “3-2-1 buydown” or “2-1 buydown.” We’ll explain what each arrangement looks like later.
How much does it cost to buy a mortgage?
Each mortgage point a borrower pays is typically equal to 1 percent of the loan amount and typically lowers the interest rate by 0.25 percentage point. For example, one point would lower your mortgage interest rate from 6 percent to 5.75 percent. However, the amount each discount point reduces your interest rate may vary from lender to lender.
Example of mortgage purchase
Suppose your mortgage lender offers you, the borrower, a 0.25% reduction in your interest rate in exchange for purchasing 1 point. So, if the loan amount is $500,000 and the interest rate is 6%, the borrower can prepay $5,000 (1% of $500,000) and reduce the interest rate to 5.75% with one discount point.
When should you consider buying a mortgage?
If your goal is to lower your monthly payments, a mortgage buydown can be a smart strategy, especially in a high interest rate environment. But that’s not right for all buyers. Whether a buyout makes sense depends on who is paying for it, how long you plan to live in the home, and whether you want short-term or long-term payment relief.
A mortgage buyout makes the most sense in the following cases:
The seller or builder pays the cost.
This is the most attractive scenario for buyers. In a buyer’s market, sellers and home builders often offer interest buybacks as concessions to help move inventory. This is usually a good deal because you get the benefit of lower interest rates without paying any costs yourself.
You want to keep your payments low for the first few years.
Many buyers use temporary buydowns, such as 2-1 or 3-2-1 buydowns, to ease homeownership. This can be helpful if you’re expecting an increase in income, adjusting to new housing costs, or need extra cash flow for a move or home improvements.
You plan to stay in the home long enough to justify the upfront cost.
Paying for the purchase price yourself usually only makes sense if you plan to live in the home long enough for your monthly savings to offset the cost of the discount points.
You’ll want to buy when interest rates are relatively high.
Buydowns are most popular when mortgage rates are rising and buyers are looking for a way to improve affordability without waiting for rates to drop.
When buying a mortgage loan is not appropriate
An acquisition may not make sense if:
You don’t have enough cash after covering your down payment and closing costs You’re planning to sell or refinance in the near future You want to use the money to increase your down payment
In some cases, putting the extra cash towards your down payment or keeping it in savings can give you more flexibility than locking it into discount points.
Types of mortgage purchase
There are three common temporary mortgage buydown arrangements: 3-2-1 buydowns, 2-1 buydowns, and 1-0 buydowns. Check out how each of these options works below.
What is a 3-2-1 buydown?
A 3-2-1 buydown allows the borrower to pay a lower interest rate during the first three years of the loan. Your first year’s interest rate is 3 percentage points below the current rate and increases by 1 percentage point each year for the next two years. The interest rate in the fourth year matches the interest rate you fixed at the beginning of your mortgage.
See the table below to see how a 3-2-1 mortgage buydown affects a buyer’s monthly mortgage payment on a $400,000 30-year loan with a 6% interest rate.
Annual Interest Monthly Payment Monthly Savings Annual Savings 13%$1,686$712$8,544 24%$1,910$488$5,856 35%$2,147$251$3,012 4-306%$2,398$0$0
The number of mortgage points charged for a purchase varies by lender. However, you will find that the acquisition cost is usually about the same amount as the buyer saves in interest. Using the example above, the mortgage purchase cost would be approximately $17,412.
2-1 What is a buydown?
A 2-1 mortgage buyout is similar to a 3-2-1 structure, except that the discounted interest rate is only for the first two years of the loan term. This provides buyers with an interest rate that is 2% less in the first year and 1% less in the second year than the standard rate.
Using the same example above, let’s see how a 2-1 buydown would play out if you took out a $400,000 30-year loan at a standard interest rate of 6%.
Annual Interest Monthly Payment Monthly Savings Annual Savings 14%$1,910$488$5,856 25%$2,147$251$3,012 3-306%$2,398$0$0
Over the first two years of the loan term, the buyer will save approximately $8,868 in interest. Knowing this, you can expect a 2-1 buydown to cost about the same.
What is a 1-0 buydown?
A 1-0 buydown means your interest rate will be reduced by 1% in the first year only. Check out the chart below to see how this structure works across a $400,000 30-year loan.
Annual interest rate Monthly payment Monthly savings Annual savings 15%$2,147$251$3,012 2-306%$2,398$0$0
Use our monthly mortgage calculator to calculate your estimated monthly payments for various interest rates.
Advantages and disadvantages of buying a mortgage loan
Under the right circumstances, a mortgage buyout can be a great option for both home buyers and sellers. Understanding your situation and being aware of the costs involved can help you avoid some of the potential pitfalls.
Strong Points
Cons
Lower monthly payments Save money on interest over the life of your mortgage Sellers can use buydowns as a negotiating tactic to attract buyers Lower monthly costs for the first few years, making it easier to finance home improvements Mortgage buydowns have higher initial costs Lower monthly payments are usually temporary (unless it’s a permanent mortgage buyout) Selling before break-even can result in a loss
Who pays the mortgage purchase costs?
Although the buyer ultimately benefits from the mortgage buydown, the seller and builder can also purchase discount points to lower the buyer’s interest rate.
I will bear the cost myself.
Mortgage buydowns are typically negotiated between the buyer and the lender. If you have extra cash after budgeting for a down payment, you can use that money to prepay mortgage points to lower your interest rate.
ask the seller to pay the price
If a seller needs to sell their home quickly or is selling in a buyer’s market, they may offer to pay the purchase cost of the mortgage interest as an incentive to buy the home. In this case, the seller may make a one-time deposit into escrow, pay points on the entire loan as part of the seller’s concession, or pay the closing costs that the seller agrees to pay. This money gives mortgage lenders money to lower interest rates for buyers, making it easier for buyers to buy a home. However, sellers may try to offset their expenses by adding mortgage purchase costs to the purchase price of the home.
Use builder closing cost incentives
Home builders may offer financing incentives for the purchase of new construction. This money can be used to cover closing costs, such as interest buybacks.
Redeem gift funds
If a family member or close friend gifted you funds, you can use that money to buy down your mortgage interest. However, there are limits to the amount that can be gifted without incurring gift tax.
Frequently asked questions regarding mortgage purchase
What are the alternatives to a mortgage buydown?
Adjustable rate mortgages (ARMs) and refinancing are potential options for people who want to save on their mortgage payments.
Note that both depend on changes in market rates. Refinancing is only worth it if interest rates go down, whereas with an ARM you could be forced to pay higher if interest rates go up.
What are other ways to lower interest rates?
If you want to reduce the amount of interest you pay without paying additional money upfront, you can start by taking steps to improve your credit score. The higher your score, the lower your mortgage interest rate and lower your monthly payments.
Talk to your mortgage lender
Be sure to work with your mortgage lender to find the best mortgage buyout arrangement for you. Or find out if a mortgage buyout makes sense at all for your situation.
Redfin does not provide legal, tax, or financial advice. This article is for informational purposes only and is not a substitute for professional advice from a licensed attorney, tax professional, or financial advisor.
