Interest Rate Buydowns
An interest rate buydown is a strategy that enables you to qualify for a larger loan and afford a more expensive home than you might otherwise be able to. Essentially, it allows you to pay extra points upfront (which are tax-deductible) in exchange for a lower interest rate during the initial years of the mortgage. Buydowns are particularly popular among individuals relocating for work, as employers often cover the cost of these extra points as part of a relocation package.
While the most typical method for obtaining a buydown is by paying extra points upfront, some mortgage companies now adjust the loan’s interest rate in future years to cover the cost.
One of the most common types of buydowns is the 2-1 buydown, which can require an additional 3 points above the current market rate. In this case, the interest rate is reduced by 2% in the first year, 1% in the second year, and then reverts to the original rate for the remainder of the loan. For example, if you have a 7% interest rate on a 30-year fixed mortgage, you would pay 5% in the first year, 6% in the second year, and 7% for the rest of the loan term.
Another option is the 3-2-1 buydown, which lowers the interest rate by 3% in the first year, 2% in the second year, and 1% in the third year, after which the full interest rate applies.
Some mortgage programs offer flex-fixed buydowns, where the interest rate increases at six-month intervals instead of annually.