Mortgage rates aren’t so low these days. In fact, they’ve basically doubled since early 2022.
While this clearly isn’t great news for aspiring home buyers or those looking to refinance, it has opened the doors to some creative solutions.
Lately, the temporary buydown has taken center stage after being a very niche product.
And many home buyers are opting to pay discount points at closing to lower their rate.
The question is do you want to permanently buy down your rate, or only do so temporarily?
Temporary vs. Permanent Mortgage Buydowns
First, you need to know the difference between a temporary buydown and a permanent buydown.
Permanent Buydown (Paying Points at Closing for a Reduced Rate for the Life of the Loan)
The permanent buydown involves paying discount points at closing to lower your mortgage rate for the life of the loan.
For example, say you’ve got a $500,000 loan amount and are offered a rate of 6.5% on a 30-year fixed mortgage with no points.
That would result in a monthly principal and interest payment of $3,160.34.
You’re not too impressed because you’ve seen advertised rates in the 5% range and so you inquire about that.
The loan officer or broker explains that you can get a rate of 5.75% if you’re willing to pay two discount points at closing.
You’d owe $10,000 at closing to buy down the mortgage rate but you’d have that rate locked in for all 30 years.
The payment would drop to $2,917.86, representing savings of nearly $250 per month. Not bad. But you still need to recoup your $10,000!
Temporary Buydown (Receiving a Reduced Mortgage Rate in Years 1-2 Only)
Then there’s the temporary buydown, which as the name implies, is temporary. That means your mortgage rate will only be lower for a short period of time.
In most cases, we’re talking the first one or two years of your loan, which will likely be a 30-year loan term.
So for years 28 through 30, the temporary buydown will do you no good. And perhaps worse, the mortgage rate will return to what it was supposed to be, sans buydown.
For example, if you elected to use a 2-1 buydown, it would temporarily reduce your interest rate by 2% in year one and 1% in year two.
If the note rate were 6.5%, you’d enjoy a rate of 4.5% the first year and 5.5% the second year. But after that the savings would end.
You’d then be on the hook for the full 6.5% mortgage rate, which could create some payment shock.
By shock, I mean making a higher payment than what you were used to. After all, it’s easy to get used to a lower monthly payment, then feel blindsided when it increases.
As a real-world example, imagine if the loan amount were $500,000. The payment would rise from $2,533.43 to $2,838.95 and finally to $3,160.34.
The saving grace is that it’s somewhat gradual because the rate is reduced 2% in year one, but just 1% in year two.
That way the jump in payment isn’t as drastic. Still, it’s a very temporary solution to lower payments.
The Decision Might Depend on Where Rates Go Next (And Where You Might Go!)
|$500,000 Loan Amount||Temporary Buydown||Permanent Buydown|
|Mortgage Rate||4.5% in year one, 5.5% in year two, 6.5% thereafter||5.75% for the life of the loan|
|Cost of Buydown||$11,379.60||$10,000|
|Monthly P&I in Years 1-2||$2,533.43 in year one, $2,838.95 in year two||$2,917.86|
|Monthly P&I in Years 3-30||$3,160.34||$2,917.86|
Now that we know how each type of buydown works, we can discuss which might be better suited for certain situations.
Most proponents of the temporary buydown point to the elevated mortgage rates currently on offer.
To that end, they see it as a bridge to a lower mortgage rate in the near-future once interest rates come back down.
They argue you’ll only need it for a year or two before rates come down and you get the opportunity to apply for a rate and term refinance.
Additionally, you only pay for what you’ll actually use (the temporary buydown funds are put in an escrowed buydown account and are typically refunded if you sell/refi before they’re exhausted).
On the other hand, the permanent buydown could result in paying for something you don’t actually use.
For example, imagine if you pay two points at closing ($10,000 in our example), and then rates unexpectedly plummet.
All of a sudden you’re in the money to refinance, but you’re hesitant because you paid those non-refundable points upfront.
If rates fall enough, say to 5%, you’d likely need to eat that cost and go for the refinance to save even more.
If mortgage rates don’t fall dramatically, you could still lose out if you turn around and sell your property before breaking even on the upfront cost.
At that point, the bought-down rate will do you no good either. So you really need to think about your expected tenure in the home (and the loan) before paying points for a permanent buydown.
Can You Finance Mortgage Points?
For the record, there’s also the financed permanent buydown mortgage, which allows you to roll the points into the loan amount.
Instead of a $500,000 loan amount, you’d wind up with a $510,000 loan amount in our example. But the lower interest rate would still equate to a cheaper payment.
It could even increase your purchasing power at the same time, allowing you to buy more home.
While the financing aspect can reduce your cash burden at closing, it still leaves you in a pickle if you refinance or sell shortly after.
You’re stuck with a larger loan amount if you refinance or less proceeds if you sell. So not totally ideal either if you don’t keep the home/loan for a long period of time.
Which Is the Better Option?
To sum things up, be sure you understand the difference between a temporary and permanent buydown to ensure you aren’t paying extra for what you may not use.
Or perhaps buying a home you might not be able to afford at the actual interest rate!
For those who plan to stay in their home awhile, the permanent buydown could make more sense.
But this assumes mortgage rates don’t fall dramatically. Because if they do, a refinance would likely be in the cards.
Conversely, if you expect to sell or refinance sooner rather than later, the temporary buydown could be more favorable.
It reduces the chances of leaving money on the table if you don’t think you’ll hit the break-even period.
Of course, if rates don’t fall, or even rise (and you don’t sell), you might have wished for the permanent buydown.