What Homebuyers NEED To Know About Interest Rate Buy-Downs| Ep. 22
Interest Rate Buy Downs: What Home Buyers Need to Know
What if I told you you could save $800 a month on your mortgage payment without having to make a bigger down payment? That sounds too good to be true, right? Well, that's exactly what many builders and sellers are offering through interest rate buy downs.
Understanding Interest Rate Buy Downs
In today's housing market, we've seen mortgage rates climb from historic lows around 3% to the mid to high 6% range. This dramatic increase has significantly impacted affordability and monthly payments. For example, on a $500,000 loan, the difference between a 3% rate and a 6% rate is about $900 per month in principal and interest payments alone—before we even factor in property taxes and insurance.
Sellers understand that higher rates are keeping many qualified buyers on the sidelines. Rather than dropping their prices dramatically, many sellers, and especially builders, are offering to help buyers reduce their interest rates through buy down programs.
Types of Buy Downs
1. Temporary Buy Downs
The most common is the 2-1 buy down. Here's how it works:
- **Year 1**: Interest rate is 2% below market rate
- **Year 2**: Interest rate is 1% below market rate
- **Year 3 and beyond**: Full market rate applies
For example, with a market rate of 6.5% on a $500,000 loan:
- Year 1 (4.5%): $2,533 per month
- Year 2 (5.5%): $2,838 per month
- Year 3+ (6.5%): $3,160 per month
The first year alone could save you over $600 monthly. The idea is that your income will hopefully increase over these first two years, making the full payment more manageable when it kicks in. Alternatively, if rates drop during this period, you might have the opportunity to refinance.
2. Permanent Buy Downs
With permanent buy downs, you or the seller pays points upfront to permanently reduce your interest rate. Typically:
- 1 point costs 1% of your loan amount
- Each point reduces your rate by about 0.25%
For instance, on a $500,000 loan, paying $5,000 (one point) might reduce your rate from 6.5% to 6.25%, saving about $80 monthly for the entire loan term.
Pros and Cons
Temporary Buy Downs
**Pros:**
- Lower payments in early years
- Time to adjust to homeownership expenses
- Potential for income growth before full payment kicks in
- Typically paid for by the seller
**Cons:**
- Payment shock when full rate kicks in
- May create a false sense of affordability
- Lifestyle expansion might offset income growth
Permanent Buy Downs
**Pros:**
- Lower payment locked in for life of loan
- Particularly valuable for long-term homeownership
- Points are tax deductible if you itemize
**Cons:**
- Significant upfront cost
- Takes time to break even
- Money might be better used for down payment or improvements
Key Considerations for Buy Downs
1. **Do the Math**: Calculate your break-even point with permanent buy downs
2. **Consider Your Timeline**: How long do you plan to stay in the home?
3. **Evaluate Opportunity Cost**: What else could you do with that money?
Real-World Success Story
Recently, I worked with a couple purchasing a $725,000 new construction home. The builder offered a 2-1 buy down on their $580,000 loan, potentially saving them $825 monthly in year one and $412 monthly in year two—about $14,800 total.
However, we discovered the builder was paying $23,000 to the lender for this buy down. Instead of accepting the buy down, we negotiated a $23,000 price reduction, which:
- Reduced their down payment requirement by $4,600
- Permanently lowered their monthly payment
- Decreased their property taxes
- Eliminated payment shock after year two
This strategy saved them over $35,000 in their first five years of homeownership.
Key Takeaway
Always ask what the buy down costs the seller—sometimes that money can work harder for you in other ways. While buy downs can be attractive, they're just one tool in the negotiation toolbox. Sometimes a straight price reduction might serve you better in the long run.
