Rising interest rates can be a major concern if you’re shopping for a new home. A higher rate reduces your buying power and increases the home cost thousands of dollars over the course of the loan. One option to avoid this is to “buy down” your loan rate. This allows you to purchase your home at a more attractive rate.
A rate buydown is when you pay an upfront fee in exchange for a lower interest rate. This increases your closing costs and for every 1% of the purchase price you pay in points, your mortgage interest rate is reduced. Buying a lower interest rate may be a good strategy for a home you intend to keep for a long time, thus making up the difference over the life of the loan.
There are a couple options for a rate buydown. The first is a simple payment of increased closing costs up front in exchange for a lower interest rate. The buydown lasts for as long as you have the loan and is requested by the buyer.
The second is a temporary buydown often initiated by a homebuilder or lender to incentivize a purchase. In this case, the buydown is for a set period, two or three years, and then the rate will return to the higher rate if the borrower does not refinance. This strategy is a good one for a starter home or if one believes the interest rates will be lower in a few years.
Utilizing a buydown as part of your loan origination can be a smart way to save money and maximize your purchasing power. It’s important to recognize the breakeven point, however, so that you know when you have started gaining money on the plan.