Buying a home with today’s rates and prices can make the dream of homeownership feel out of reach. To help make owning a home possible for more people, many sellers and builders now offer temporary buydowns.
What is a Temporary Buydown?
A temporary buydown lowers a new homeowner’s monthly mortgage payments by reducing the interest rate for the first one to three years of the loan. In this arrangement, the seller or builder only needs to provide the credit while the lender applies those funds to the monthly payments during the introductory period.
This strategy helps a homebuyer ease into their mortgage payment while freeing up funds for other moving related expenses.
How Does a Temporary Buydown Work?
A seller credit is placed into an escrow account at the time of closing. These funds are specifically designated to supplement the borrower’s monthly payments for the term of the buydown. Since this money is already set aside, the lower payment is guaranteed for the duration of the buydown period.
Important information regarding qualification: To ensure long-term financial stability, the buyer must be approved at the full “note rate” (the permanent interest rate). This confirms that the buyer can comfortably afford the monthly payment after the temporary buydown period has expired.
There are Three Common Types of Temporary Buydowns:
1-0 Buydown: Reduces the note rate by 1% for the first 12 months.
2-1 Buydown: Reduces the note rate by 2% for the first year, then 1% the second year. Years 3-30 will be at the original note rate.
3-2-1 Buydown: Reduces the note rate by 3% the first year, 2% the second year, 1% the third year, and years 4-30 will return to the original note rate.
Example 2-1 Buydown
Example is based on a sales price of $250,000 with a base loan amount of $225,000, and seller paid buydown funds of $5,304.
| Period | Down Payment | Interest Rate | APR | Est. MI | Monthly Payment | Annual Savings |
|---|---|---|---|---|---|---|
| Year 1 | $25,000 | 5.25% | 7.294% | $41.25 | $1,283 | $3,516 |
| Year 2 | – | 6.25% | 7.294% | $41.25 | $1,426 | $1,800 |
| Year 3+ | – | 7.25% | 7.294% | $41.25 | $1,576 | – |
This program uses a seller funded buydown subsidy to lower borrower’s P&I payments for the first 24 payments on the loan. Buydown subsidy in this example is $5,204 based on a $250,000 sales price, loan amount $225,000, and credit score 760. APR = Annual Percentage Rate. This is for informational purposes only, rates are subject to change without notice.
While buydowns offer thousands of dollars in upfront savings for buyers, the value goes beyond the monthly payment. As a powerful negotiation tool, buydowns help buyers enjoy immediate financial relief while sellers gain a competitive edge to close the deal without slashing their asking price.
What are the Benefits of a Temporary Buydown?
Benefits for the Seller:
Offering a temporary buydown is often a better alternative than dropping the sales price of the home. This way, the seller can maintain their asking price while still providing the buyer with a lower monthly payment.
- Faster Sales: Offering seller credits can help a listing stand out in a competitive market.
- Cost Efficiency: Price reductions are often more expensive for a seller than offering a targeted credit.
- Incentive: It serves as a powerful “goodwill” gesture to help a buyer manage their initial costs.
Benefits for the Buyer:
Temporary buydowns provide a smoother transition into homeownership, especially for buyers who expect their income to increase over time.
- Gradual Adjustment: New homeowners can ease into their long-term budget by paying less than the actual fixed-rate payment for the first few years.
- Stable Loan Amount: Unlike some other financing options, a buydown does not increase the principal loan amount.
- Safe Savings: It is a secure way to get lower payments in a high-interest-rate environment.
- Cash Flow: It frees up funds for moving expenses, buying furniture (after you close), or building an emergency fund.
While the immediate savings are what draw buyers in, many homeowners are looking towards the future. As market conditions shift, buyers may want to refinance if interest rates happen to drop
What Happens if you Refinance Before the Buydown Period Ends?
If interest rates drop and you choose to refinance before the buydown period ends, you do not lose those funds. Instead, the remaining balance in the escrow account is applied directly towards your principal loan balance. This reduces your total debt and gives you a head start on your new loan!
Who is a Temporary Buydown For?
While anyone can benefit from lower payments, this strategy is particularly effective for certain types of buyers:
- Career Path Growers: Professionals who expect their income to increase significantly over the next few years.
- Cash-Conscious Buyers: People who want to keep more liquidity on hand for immediate home renovations or moving costs.
- Transition Households: Families moving from a dual-income to a single-income household temporarily, such as those planning for a new child.
Now we know who benefits most from this program, but how does it stack up against other popular interest rate reduction methods? While temporary buydowns focus on significant short-term relief, other options like discount points or adjustable-rate mortgages offer alternative methods for saving money.
Discount Points vs Temporary Buydown
Another way borrowers reduce their rate is by paying discount points. This involves paying a one-time fee at closing to permanently reduce the interest rate. While points provide savings over the entire life of the loan, a temporary buydown offers much more significant, immediate savings during the first few years.
Adjustable-Rate Mortgages (ARMs) vs Temporary Buydown
With an ARM, the interest rate can fluctuate over the life of the loan based on market conditions. Alternatively, the interest rate on a temporary buydown is fixed from the start. The payment is only lower because the seller pre-paid a portion of the interest, making a buydown much more predictable and lower-risk option.
Is a Temporary Buydown Right for You?
Whether you are buying your first home or looking to sell your current property faster, we are here to help. Contact our team today to see if a temporary buydown is the right strategy for your next move!
