Rising interests have put shopping plans on pause for many would-be homebuyers. That may be good for inflation, but it also means houses sit on the market longer while reluctant buyers look for creative ways to shave points off current interest rates.
An interest rate buydown is a simple and creative way to temporarily reduce interest rates for a set amount of time at the beginning of your mortgage. That means interest savings and lower monthly payments for qualified buyers.
So how do interest rate buydowns work? We’ll explain everything here.
How Does an Interest Rate Buydown Work?
Typically, interest rate buydowns allow buyers to begin their mortgage at a reduced interest rate, which remains locked for two years. After that, your interest rate will rise one percentage point per year for two years. Then you will resume paying your normal rate for the remainder of your loan term.
So let’s assume your full interest rate is six percent, but you qualified for a 2-1 interest rate buydown. In that case, you’ll pay four percent interest for the first year, five percent the second, and then you’ll resume your normal six percent rate the third year and beyond.
The difference between those two rates is placed in escrow and covered by an investor—your lender, seller, or realtor. The investor still receives a payment from that escrow account to make up for the difference. Meanwhile, you enjoy a lower interest rate.
What Kinds of Interest Rate Buydowns are Available?
In general, there are two types of temporary buydowns.
- A 1-0 buydown offers a one percent interest-rate reduction for the first year of the loan. Thereafter, your interest rate resumes its normal rate.
- A 2-1 buydown offers a two percent interest-rate reduction for the first year. That rate increases by one percent in the second year and then resumes to a normal rate for the duration of the loan.
Advantages and Disadvantages of Interest Rate Buydowns
Let’s start with the advantages of a temporary buydown.
- First, you’ll pay less interest. Remember, when you qualify for a buydown, your investor pays extra interest from an escrow account. And you reap the rewards.
- Second, you get to ease into your mortgage. Paying a reduced interest rate for the first two years frees up extra cash you can rechannel into other investments or use for home-improvement projects.
The list of downsides is short. The big one is that your offer on a new home will be less competitive, especially if the seller has multiple offers. However, if the house has not moved and the seller is not fielding multiple offers, your offer may still be accepted.
What are the Restrictions?
The good news is that interest rate buydowns are available on Fannie Mae, Freddie Mac, FHA, and VA loans. However, you will have to lock in an interest rate before the beginning of the year.
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