How Does a Buy-Down Mortgage Work?

"Buying down the rate" is another term for a buy-down mortgage.

"Buying down the rate" is another term for a buy-down mortgage.

You might investigate a buy-down mortgage if you don’t quite meet lender income requirements. Homebuyers who choose the buy-down option pay lower interest rates on home loans and lower monthly payments. Builders and home sellers offer buy-down options, usually on fixes-rate loans, to qualify more buyers for loans and increase sale potential with the low-payment incentive. The different types of buy-down mortgages and plans are designed to accommodate your financial needs, including income, expenses and debt.

Understanding Buy-Down Mortgages

The low monthly payments available with a buy-down mortgage are possible because a cash deposit is made either as an advance payment or as an amount that is built into the mortgage and paid over the life of the loan. The process requires a cash payment paid to the lender by the buyer, seller or builder. Sometimes the buyer and seller agree to share the cost of the advance cash payment. The two types of buy-down mortgages, temporary and permanent, are designed to meet different financial needs.

Temporary Buy-Down

The temporary buy-down option works well if you expect to increase your earnings in a few years or pay down a significant debt that currently ties up income. The 3-2-1 plan, for example, requires an upfront payment that reduces the interest rate in the first, second and third years by 3, 2 and 1 percent, respectively.

Permanent Buy-Down

Buyers who choose the permanent buy-down pay additional mortgage points, which are the fees paid at closing to the lender, to reduce the interest rate and the monthly payment for the life of the loan. You must have enough cash on hand to pay for the mortgage points, down payment and closing costs. One point equals 1 percent of the amount of your home loan, or $1,000 per $100,000. For instance, you would pay the lender $2,500 on a $250,000 mortgage. Lenders vary in the rate reductions applied to mortgage points. If you know up front you'll be doing a buy down, you should mention that while shopping for the best rates on a mortgage.

When Buy Downs Work

The cash advance payment for the temporary buy down is placed in an escrow account and used to supplement your monthly payments to the lender. Although you make reduced payments during the buy-down period, the lender receives payment amounts as expected without a buy down. According to BancCorp South, because a buydown can be so costly, it's a good idea only if you plan to stay in your home a while. Another instance where it's a good idea is when you're trying to buy a home for more than its appraised value. You can buy your way down to that amount so that you can qualify for the mortgage. Builders often prefer buy-downs to lowering the price of homes, which can lower the value of other property in the area. A buy down does not affect property value or property taxes.

When to Avoid Buy Downs

If you don't plan to stay in your new home a while, a buy down may not be the best idea. If you end up moving within five years of your home purchase, you won't be able to recoup the extra money you put in. Also if you're going with an adjustable-rate mortgage, points shouldn't even come into play, since a buy down won't save you money on your mortgage. You'll also need to make sure you have the cash in the bank to pay for the buy down, although in some instances the seller may agree to pay for the buy down as part of the negotiation process.

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About the Author

Gail Sessoms, a grant writer and nonprofit consultant, writes about nonprofit, small business and personal finance issues. She volunteers as a court-appointed child advocate, has a background in social services and writes about issues important to families. Sessoms holds a Bachelor of Arts degree in liberal studies.

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