I’ve had a lot of questions from clients asking about what a mortgage buydown is and how it may help them. Last week, I had the opportunity to speak with Drew Wayman of Fairway Independent Mortgage, a great financial advisor. Here’s what he had to say.
“A mortgage buydown is a financial arrangement in which a homebuyer, a builder, or a seller pays an upfront fee to the lender in exchange for a reduced interest rate on a mortgage loan for a specific period. This arrangement is typically used to make the initial mortgage payments more affordable for the homeowner. There are two common types of mortgages buydowns: temporary buydowns and permanent buydowns.”
Here's a few ways mortgage buydown’s work:
1. Temporary Buydown: In a temporary buydown, the homebuyer or another party pays an upfront fee to the lender. This fee is used to subsidize the mortgage interest rate for the first few years of the loan term. The interest rate is reduced during this initial period, making the monthly mortgage payments lower than they would be with a standard fixed-rate mortgage.
For example, in a 2-1 buydown, the interest rate might be reduced by 2% in the first year and by 1% in the second year, after which the rate returns to the original rate for the remaining term of the loan.
Benefits of Temporary Buydown:
Lower Initial Payments: Temporary buydowns allow homeowners to have lower initial monthly payments, which can be particularly helpful during the early years of homeownership when financial flexibility might be limited.
Easier Qualification: Reduced initial payments can help buyers qualify for a larger loan amount, making it easier to afford the home they want.
Risks of Temporary Buydown:
Higher Long-Term Costs: While the initial payments are lower, the interest rate will eventually revert to the original rate, leading to higher monthly payments after the buydown period ends.
Upfront Costs: Buyers need to pay an upfront fee to participate in the buydown, which can be a substantial sum depending on the terms of the buydown.
2. Permanent Buydown: A permanent buydown involves paying an upfront fee to permanently reduce the interest rate over the entire term of the loan. The interest rate remains lower than the prevailing market rate for the entire loan duration.
Benefits of Permanent Buydown:
Steady Savings: Homeowners can enjoy consistent savings throughout the life of the loan, as their monthly payments are lower due to the reduced interest rate.
Long-Term Affordability: Lower interest rates contribute to more manageable monthly payments, making homeownership more affordable over the long run.
Risks of Permanent Buydown:
Upfront Costs: Just like temporary buydowns, permanent buydowns come with an upfront cost that can be substantial and affect the buyer's available funds for other purposes.
Opportunity Cost: The money used for the upfront buydown fee could potentially have been invested elsewhere, potentially generating higher returns than the interest savings from the buydown.
“In both cases, it's essential for prospective homeowners to carefully evaluate their financial situation, their plans for the property, and their long-term goals before opting for a mortgage buydown,” said Drew.
Consulting with mortgage professionals like Drew can help you make an informed decision based on your individual circumstances.
In good health,
Daniel Henry, AH Heritage Home Group of Coldwell Banker