Want a Cheaper Mortgage? Try a Rate Buydown

Even as average mortgage rates remain high, there are ways to make homeownership more affordable. 

Here's one strategy: With a mortgage rate buydown, you can pay money to lower your rate permanently or temporarily. 

If you plan to stay in your home for a while, a permanent rate buydown can help you save on interest in the long term, though you'll have to pay money upfront. A temporary buydown eases you into your new mortgage payment and helps you save money for a short period of time, with someone else generally covering the upfront deposit.

With both options, it's important to know how they work. Here's what to know. 

How does a mortgage rate buydown work?

Depending on the type of buydown you choose, the lower rate may either be temporary or permanent. 

Permanent buydowns

Permanent buydowns are also known as purchasing discount points or buying down your rate. As a homebuyer, you pay your lender an upfront fee in exchange for a lower rate. Each discount point you purchase lowers your mortgage rate by a small amount, and you keep that lower rate for the entire loan term.   

Temporary buydowns

A temporary rate buydown usually means the seller, builder or mortgage lender makes an upfront deposit in exchange for offering you a lower mortgage rate for the first year or the first few years. As a homebuyer, that means you'll have discounted payments for a year or more. 

Here's a breakdown of different types of temporary buydowns:

• 2-1 buydown: The lender reduces your interest rate by 2% in year one and 1% in year two. You'll pay the full standard rate starting in the third year and for the remainder of the loan term.
• 3-2-1 buydown: Your rate is lowered by 3% in the first year, 2% in the second year and 1% in the third. Starting in year four, you'll pay the full rate for the rest of the loan term. 
• 1-1 buydown: The mortgage rate drops by 1% for the first two years before rising to the permanent rate for the rest of the loan term. 
• 1-0 buydown: Your lender reduces your interest rate by 1% for just the first year of the loan. Then, you pay the regular rate for the remainder of the term.

The cost of a buydown

Buying down your rate isn't exactly cheap. With a permanent buydown, you buy "points" upfront, with one discount point equal to 1% of the loan amount. Each point typically lowers your rate by around 0.25%. For instance, you'd pay $4,000 to buy one point on a $400,000 loan. Keep in mind that your lender may limit the number of discount points you can buy. 

The cost of a temporary buydown can depend on your lender, the loan type and other factors, but the fee is often calculated as the difference between monthly payments with your standard interest rate versus payments with the lower "buydown" rate. A 2-1 buydown on a $400,000 home with a 7% interest rate, for example, would cost about $7,500 upfront, assuming you made a 20% down payment and chose a 30-year term. Again, most temporary buydowns are traditionally paid for by builders, sellers or lenders as a closing cost.

Is a mortgage buydown right for you?

A permanent buydown could be beneficial if you plan to stay in your home after recouping the costs of buying discount points. This option is usually best when rates are trending upward.

A temporary rate buydown is usually a win-win situation if someone else pays the upfront fee and you can afford the higher payments after the rate rises.  

Nicole Rueth, a branch manager and senior vice president at Movement Mortgage, says a temporary rate buydown can be a game-changer for buyers who expect their income to increase or plan to refinance when rates drop. 

A temporary buydown can also be beneficial if rates drop because the buydown funds are refundable, and will be applied to your principal balance when you refinance, said Colin Robertson, founder of The Truth About Mortgage. With a permanent rate buydown, the cost isn't refundable if you refinance.

The downside to a temporary buydown? It's only a temporary fix.  

"If rates don't improve or income doesn't rise as planned, today's buyers will face higher payments later on," Rueth says.

You'll still need to consider whether you're getting a good deal with a temporary buydown. For example, is your lender still offering a competitive permanent rate? Or, if the seller is paying for it, are you making some type of trade-off in the sale?

If you're considering covering the upfront deposit yourself to get a few years of a discounted rate, you might instead opt to open an emergency fund specifically for housing expenses. "This will help you offset your payments on an as-needed basis," Rueth says. 

Other ways to find cheaper mortgages

If a rate buydown isn't the right choice for you, consider some of these alternatives:

Take out an adjustable-rate mortgage

An adjustable-rate mortgage, or ARM, starts off with a lower fixed interest rate for a prespecified period, such as five years. After that period ends, the rate can go up or down at set intervals for the remaining loan term. The rate adjustments are tied to changes in the overall economy.

An ARM could be a good option if you plan on selling or refinancing your home before the higher rate kicks in.

Refinance your home loan

Refinancing a home loan involves taking out a new loan that pays off your initial mortgage. Homeowners do this for various reasons, such as lowering their interest rate, choosing a new term, borrowing cash or changing their rate structure. 

Refinancing could be a good alternative if rates are high but you don't want to pay the upfront costs of a buydown. You could plan on buying the home and refinancing when rates drop, but the mortgage market is unpredictable and there's no guarantee this will happen. 

Recast your home loan

With a recast, you make a lump-sum payment toward your home loan principal and ask your lender to calculate a new amortization schedule. Because your new mortgage payments are based on a smaller loan balance, it shrinks your monthly payment and lowers your total interest costs. 

A mortgage recast is a good option if you don't want a new interest rate and have cash on hand. Some homeowners recast when they buy a new house before selling their current one. 

More on homebuying:

• Why Fed Rate Cuts Aren't a Cure-All for High Mortgage Rates
• Forget Mortgage Rates. Americans Say They Can't Even Save for a Down Payment
• You Might Be Eager to Buy a House, but Homeowners Are Holding Tight to Their Mortgages
• Despite Lower Mortgage Rates, Another Refinancing Boom Isn't Likely. Here's Why