How to buy down your mortgage interest rate

Mortgage rates are lower than this time last year, but they’re still nowhere near the lows we saw in 2020 and 2021. However, there is a way to lower your mortgage costs: a buydown interest rate.

With this method, you pay money at closing to lower your mortgage interest rate. While it costs more money up-front, it can lead to greater savings over the life of the loan. But it’s a more beneficial tactic if you plan to stay in the home for a while — the longer you keep the mortgage loan, the more you’ll save by buying down the rate.

While having a lower mortgage rate has perks, there are also factors to consider before buying down your interest rate.

Learn more: When will mortgage rates go down?

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When you buy down your mortgage rate, you pay extra money at closing to purchase points that essentially lower your interest rate.

Different lenders have their own mortgage rate buydown programs, so there might be a slight difference in the calculation and loan terms. Be sure to ask several mortgage lenders how their buydown programs work to help you decide which loan is right for you.

There are two ways to buy down your mortgage. “Discount points” (sometimes called “mortgage points”) refer to buying down your rate permanently, and a “mortgage buydown” does so temporarily. These two terms both refer to ways to buy down your rate and are often used interchangeably, but there are important differences.

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There are two main buydown options: a permanent or temporary buydown. As implied, the permanent buydown rate lasts for the life of the loan, while the temporary option is only for the first few years or less.

With a permanent buydown, the lower interest rate you purchased with discount points when you first got the mortgage will last for the duration of the loan as long as you don’t refinance the mortgage or change the terms. Permanent buydowns are usually purchased by the borrower.

Most lenders will only allow you to buy points for 1% to 2% of the mortgage amount, which typically lowers your rate by 0.25% and 0.50%, respectively. But some will go to 3%, which could lower your mortgage rate by 0.75%.

A temporary buydown, or “mortgage buydown,” is when your interest rate is lower for a set period of time — usually one year to three years — then resets to a higher rate for the remainder of the loan.

This type of buydown can be paid by the buyer, seller, home builder, or even a lender in some cases. These are usually paid through an escrow account.

With a temporary buydown, the rate typically increases by 1% each year. For example, if market rates are 6%, you could get a temporary buydown in which the rate is 3% the first year, 4% the second year, 5% the third year, and resets the fourth year. This is usually called a 3-2-1 buydown.

But there are other temporary buydown term options, like a 2-1 buydown, in which the rate is staggered lower for the first two years, then resets the third year. Or a 1-0 buydown, in which your rate is 1% lower for only the first year.

In all of these cases, the ideal outcome is that market rates will be lower by the time your temporary rate resets, and you’d be able to refinance into that lower market rate. This is betting on future mortgage rates, so be sure you weigh the risks before committing.

It’s important to ask your mortgage lender about any temporary buydown programs because each lender will have different options.

Looking for a mortgage lender with a buydown program? Read Yahoo Finance’s reviews of lenders that offer these types of lenders.

Are you interested in buying a new construction home? Then, you may benefit from a builder buydown. In this case, the builder (not the borrower) pays the lender so the borrower can get a lower interest rate.

Builder buydowns can be either permanent or temporary. Not all builders offer this incentive, but many do. According to the National Association of Home Builders (NAHB), around 60% of builders have been offering some sort of buyer incentives. The hope is to entice home buyers who are hesitant to buy due to high interest rates and to offset some of the company’s building costs.

Keep in mind, builder buydowns are for people getting a mortgage to buy a new construction home, not for people building houses with construction loans.

The cost to buy down your mortgage rate will vary based on the lender and your total loan amount. But you should plan to have at least several thousand dollars set aside. Keep in mind, this money is in addition to any down payment required on your mortgage and will be paid at closing as part of your closing costs.

In general, one discount point — or 1% of the mortgage amount — equates to roughly a 0.25% reduction in your mortgage rate.

So, let’s say you are offered a $400,000 mortgage with a 7% rate. If you pay $4,000 (which is 1% of your mortgage) to buy a discount point, it could reduce the mortgage rate to around 6.75%. That means you’re lowering your monthly mortgage payment from an estimated $2,661 to $2,594, saving roughly $67 per month, excluding the down payment, taxes, and other fees. Over a span of 30 years, you could save more than $24,000 with the lower mortgage rate.

But your savings is based on how long you keep that loan, so it might not be worth it if you plan to sell the house in a few years.

In the case of a temporary buydown, like a 3-2-1, the monthly savings only occurs in the early years. However, it could extend beyond the initial years if market rates are lower by the time the buydown period ends and you can refinance into a lower rate.

Let’s use the same example of a $400,000 mortgage with a full interest rate of 7%, resulting in roughly $2,661 a month in mortgage payments. With a 3-2-1 buydown, here’s what you would pay for the first three years:

Year 1: A 4% rate with a $1,910 monthly payment, saving you $751 per month
Year 2: A 5% rate with a $2,147 monthly payment, saving you $514 per month
Year 3: A 6% rate with a $2,398 monthly payment, saving you $263 per month

Based on the monthly estimates, you could save $9,012 the first year, $6,168 the second year, and $3,156 the third year, totaling more than $18,336.

Before paying more up-front to get a lower mortgage rate, consider these advantages and disadvantages of a mortgage rate buydown.

You’ll have lower monthly payments, either permanently or temporarily.
You save more in interest over the life of the loan.
If it’s a temporary buydown, you could earn significant savings during the early years of the loan.
You might qualify for a larger mortgage amount if your interest rate is lower because it would reduce your monthly mortgage payments. Lenders approve a total amount based on how much you can afford partly based on your monthly debt-to-income ratio. For example, you might be able to afford a $400,000 loan at a 5% rate because the monthly payments could be about $500 less than the same loan amount at a 7% rate.

Buying down a rate requires cash up-front, so you will have less savings after closing day.
Your closing costs will be higher.
You won’t save as much if you sell the house within a few years than if you stay in the house for a long time, because you might not have time to recoup the extra money you paid at closing for the buydown.
You’ll have higher monthly mortgage costs later if it’s a temporary buydown.

Learn more: Is it a good time to buy a house?

There are several common ways to pay for a mortgage rate buydown:

Pay more at closing. If you have extra cash after meeting the down payment requirement and other closing costs, you can pay to buy down your rate. Just be sure you don’t totally deplete your savings while moving into your new home. Do the math ahead of time, and check that you can make the monthly mortgage payments after buying down your rate.
Ask the home builder. With new construction homes, some builders will offer to buy down your rate to incentivize you to purchase their home. This may happen if they have their own partner lender, which helps them streamline the entire mortgage and homebuying process together. It can also be the case if they have newly built homes that have sat vacant for a while. If a builder is offering closing cost discounts, ask if that incentive can come in the form of a rate buydown.
Ask the seller. Sometimes, a seller will buy down your rate for you to buy their home. This is a rare case, especially in a seller’s market. However, you can ask for the seller to cover this part of your closing costs when you make an offer on a house or during the negotiation process.

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Calculate your break-even point to decide whether it’s worth it to buy down your mortgage rate. Let’s say you spend $3,000 to buy down your interest rate, which results in saving $50 on your monthly mortgage payment, or $600 per year. It would take you five years to save $3,000 on monthly payments — five years is your break-even point. If you don’t expect to stay in the home for at least five years, it probably isn’t worth buying down your interest rate.

When you buy down your interest rate, one discount point results in a 0.25% rate reduction. One discount point typically costs 1% of the amount of your mortgage. If you take out a mortgage for $300,000 and pay 1% for one discount point, you’ll pay $3,000.

A 2-1 buydown is a type of temporary interest rate buydown on your mortgage. Your rate will be 2% lower for the first year, 1% lower for the second year, then settle in at the permanent rate.

When you buy one mortgage discount point at closing, it typically lowers your interest rate by 0.25%. For example, if your original rate with no mortgage points is 6%, and you decide to pay for one point at closing, you’ll lock in a 5.75% rate instead.

A home seller might be willing to pay for a permanent or temporary rate buydown at closing if they’re having trouble selling their house at the listing price. As the the buyer, you could include that you’re willing to pay full purchase price if the seller covers certain closing costs, like discount points.

This article was edited by Laura Grace Tarpley.

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