Temporary Rate Buydowns 101

As you try and navigate purchasing a home in 2024, it may seem like an unreachable dream with interest rates near their 15 year highs!

There is good news though and that’s where temporary rate buydowns come into play! In fact, many of our clients have greatly benefited from temporary rate buydowns, which offer a strategy for enjoying lower monthly payments for a limited time. Ideal for homebuyers looking for upfront affordability, these strategies can offer substantial initial savings on your mortgage expenses.

Here’s the scoop: a temporary rate buydown lets you pay a lower interest rate for the first few years of your mortgage. It’s a way to make those initial payments more manageable while we all wait for interest rates to drop.

Okay, diving right in – how do these buydown programs work? And what are the different options available? Stick around and we’ll give you the breakdown that will light up all those bulbs over your head!

Understanding Temporary Rate Buydowns

A temporary rate buydown is an arrangement where the interest rate on your mortgage is temporarily reduced for a fixed period of your loan term, typically up to 3 years. This means lower monthly payments right out of the gate.

The beauty of a temporary rate buydown is that it doesn’t change the overall terms of your mortgage. You’re still getting the same loan, just with a little breathing room upfront. The idea is to get an affordable monthly payment now, and refinance to a permanent lower rate and payment – assuming rates drop within your buydown period.

Types of Temporary Rate Buydown Options

There are a few different flavors of temporary rate buydowns, each with its own benefits. The most common buydown options are:

• 3-2-1 buydown: Your rate is reduced by 3% in year one, 2% in year two, and 1% in year three.
• 2-1 buydown: Your rate is reduced by 2% in year one and 1% in year two.
• 1-0 buydown: Your rate is reduced by 1% for the first year.
• 1-1 buydown: Your rate is reduced by 1% for the first two years.

The 2-1 buydown is by far the most popular option, and white 3-2-1 buydown offers the most significant savings upfront, but even the 1-0 and 1-1 can make a big difference in those early years when cash flow is often the tightest.

Let’s take a look at an example 2-1 buydown scenario on a home that costs $450,000 – and let’s assume a starting interest rate is 6.99%. Here is how your rate and payments would change over the course of your loan.

As you can see in this scenario the homebuyer saves over $10,000 in their monthly payments over the first two years!

It’s important to note that after the buydown period is over, your rate and payment goes back to the original term for the remainder of the loan. Because of this, you should make sure you are comfortable with the monthly payment amount after the buydown is over, just in case rates don’t drop or something with your credit changes and no longer can qualify for a refinance, etc.

Benefits of a Temporary Rate Buydown

Why would you choose a temporary rate buydown? It all comes down to those initial savings.

The biggest perk of a temporary rate buydown is the immediate relief it provides for your monthly budget. With a lower mortgage payment in those first few years, you’ve got more wiggle room for other expenses.

Maybe you’re a first-time homebuyer adjusting to the costs of homeownership. Or perhaps you’re expecting a significant income increase down the line. A temporary buydown lets you ease into your mortgage payments and plan for the future. 

Who Pays For The Temporary Rate Buydown?

In almost all cases, the seller pays for the Temporary Rate Buydown! In a seller concession, the seller agrees to pay a portion of the buyer’s closing costs, which can include the cost of the temporary rate buydown. This can be a win-win: the seller gets a faster sale, and the buyer gets a more affordable mortgage.

Things To Consider With Temporary Rate Buydowns

While temporary rate buydowns can be a fantastic tool, they’re not without their risks and considerations.

The key word in “temporary rate buydown” is, well, temporary. It’s important to plan for the payment increase once the buydown period ends. If your income doesn’t rise to meet the higher payments, you could find yourself in a tight spot.

If you decide to refinance before the end of your buydown period, you’ll receive a refund for any remaining savings. The total amount allocated for the buydown is held in an escrow account, which is used each month to apply your savings. Therefore, if you pay off or refinance your loan during the buydown term, any unused funds will be returned to you.

Conclusion

By offering lower interest rates for the first few years, a temporary rate buydown can help you manage your cash flow and settle into your new home without breaking the bank.

Whether you opt for a 1-0, 2-1, or 3-2-1 buydown, you’ll enjoy significant savings in those initial years. And even though the rates will gradually increase, you’ll be in a better position to handle the payments down the road.

Of course, it’s important to weigh the pros and cons and crunch the numbers for your specific situation – by the way, we have an amazing temporary rate buydown calculator that will help you visualize the savings. But if a temporary rate buydown sounds like a good fit, don’t hesitate to explore your options with a trusted lender. It could be the key to making your homeownership dreams a reality.