Mortgage Buy-Downs Explained

A buy-down is a useful financial tool that can help both home-buyers and seller. Buying down the interest rate the home-buyer pays on a mortgage is a useful strategy for sellers when trying to attract more buyers to a property. Buy-downs can help sell homes in slower markets and can save both buyer and seller money.

Buy-downs can be more useful than a simple price reduction, because they have a greater impact on the buyer’s monthly mortgage payment, even in today’s low-interest-rate environment. And for most buyers, the bottom line is not so much the actual price of the house but how much they’ll have to pay each month.

Buy-downs work like this: For a fee, often paid by the seller, a lender agrees to lower the buyer’s mortgage rate for one to three years. In effect, the seller is paying points on the buyer’s behalf.

A typical buy-down, known as a “2-1″ buy-down, calls for a rate that’s 2 percentage points below market for the first year. In the loan’s second year, the rate rises to 1 percentage point below the rate at the time the loan was made. And after two years, it goes up once again, this time to the original rate, where it remains for the life of the mortgage.

Other popular versions include a 3-2-1 buy-down in which the rate is 3 points below market the first year, 2 points during the second year and 1 point in the third, and a condensed buy-down in which the rate rises every six months instead of every 12.

There are also options to buy-down the interest rate on the loan over the life of the loan. Most homeowners only own a home for 5 years on average, so it may not be cost effective to pay for a buy-down over the life of the loan.

To see how the concept works, and why it’s almost always a better bet than lowering your price, let’s assume a $165,000 selling price. If a buyer puts up $15,000 in cash as a down payment, he or she would have to finance $150,000. And at 6 percent, the payment for principal and interest would be $899 a month.

However, if the seller agrees to pay the cost of a 2-1 buy-down, the buyer’s monthly principal and interest payment at 4 percent for the first year would be $716, a difference of $183 a month or $2,196 a year. The payment would rise to $805 in the second year, but that’s still a savings of $94 a month or $1,128 for the entire year.

The payment would rise to $899 in the third year. But over the 24 months, the buyer’s total savings is $3,324.

That’s also what it would cost the seller to buy-down the buyer’s interest rate. Of course, as an alternative, you could cut your price by the same amount.  But it’s easy to see how much more meaningful it is to lower the rate rather than the price in this example: If you cut the price by $3,324, which is the cost of the buy-down, the monthly payment at 6 percent would be $879. The price reduction of $3,324 only lowers the buyer’s loan payment by $20. $3,324 used to buy-down the loan reduces the buyer’s payment by $183, which helps the buyer much more.

With the buy-down, the eventual buyer in the example above only has to earn enough to afford a $716 a month house payment rather than $879.

The differences are even more striking on higher priced houses or when mortgages are more expensive. For example, on a $250,000 mortgage at 6 percent, the monthly payment is $1,499. But at 4 percent, it’s just $1,194, a difference of $305. At 5 percent, the second year payment would be $1,342. But the total two-year savings would be $5,544.

If the seller in this case “spent” that amount to lower the selling price and thus the buyer’s mortgage to $244,456, the payment at 6 percent would be $1,465, or just $33 a month less than if the seller did absolutely nothing. There’s a big difference between $305 a month and $33.

Speak with your lender about buy-downs and ask your Realtor how to a write a buy-down into a purchase contract to help you sell or buy your home.

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You can reach Pike at 802.233.2600 or pike@castleporter.com.

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