When buying a home, what is a mortgage buydown?
This is a tactic used by sellers or buyers to help the buyer qualify for a mortgage. It is a lump sum paid at the closing. It pays the mortgage company for reducing the mortgage interest payments for two or three years.
If the seller wants to pay to allow the buyer to be qualified, the seller pays for it. If the buyer has the cash but doesn’t qualify for the payment at current interest rates, the buyer could pay up front for the reduced interest rate that would be charged for two or three years.
Example of a two-year buydown:
The home price is $134,000, if the seller pays to have interest and monthly payments reduced by 2 percent in the first year and one percent in the second year, the seller would pay the mortgage company about $4,000 at the closing.
A detailed example of a three-year buydown
- For a $350,000, 30-year mortgage at 6.75 percent interest, Â the seller (or the buyer) could pay $15,853 at closing.
- The first year interest rate is 3.75 percent and the monthly payment is $1,621 per month. This creates a first-year savings of $7,790, considering that the payment would normally be $2,270 per month.
- The second year rate is 4.75 percent, creating a monthly payment of $1,826 per month, or an annual savings of $6,332 if the payment had been $2,270.
- The third year interest rate is 5.75 percent, resulting in a monthly payment of $2,043 per month or an annual savings of $2,731. (In the 4th through 30th years, the normal payment is $2,270.)
Add up the savings, and you will find they come to $15,853 in this case, which is what it costs to buy down the interest rate and payments for three years.
There is one other advantage to the mortgage buydown: It increases the payment more gradually than introductory-rate mortgages on which the monthly payment increases dramatically after two or five years.
Note: The 30-year interest rate in this example is different than rates presently charged on most 30-year mortgages.
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