By Ashley Gower
Mar 26, 2024
If you’re in the market for a new home, you’re probably keeping an eye on the current interest rates. When rates are low, it can be easier to jump into the homebuying process, but not so much when rates are high. Fortunately, if you’re ready to buy a home now, there’s something you may be able to do to pave the way for more manageable mortgage payments, regardless of what the market is up to. One of these handy strategies is called a Temporary Buydown.
Explaining Temporary Buydown Mortgages
A Temporary Buydown is an option where a buyer is able to temporarily reduce the interest rate on their new loan, in exchange for a one-time fee at closing. This tactic can give a homebuyer some breathing room and help ease into the full mortgage payment through the first few years of the loan, especially in a high interest rate environment.
How does a Temporary Buydown Work?
There are different buydown options, each offering a specific reduction in interest rate for a set period.
At NFM, we offer three different types of temporary buydowns:
- 1 Year Buydown (1-0 ): This option allows for the effective rate of interest paid by the buyer to decrease by 1% for the first year of the mortgage loan.
- 2 Year Buydown (2-1): The option allows for the effective rate of interest paid by the buyer to decrease by 2% for the first year of the mortgage loan and 1% for the second year.
- 3 Year Buydown (3-2-1): This option allows for the effective rate of interest paid by the buyer to decrease by 3% for the first year of the mortgage loan, 2% for the second year and 1% for the third year.
Temporary Buydown Example
Let’s say you secure an 8% interest rate on a 30-year fixed-rate mortgage with a 3 year buydown (3-2-1 buydown).
- Year 1: Your payment will be based on a 5% interest rate (8% – 3% = 5%).
- Year 2: You’ll make payments calculated at a 6% interest rate (8% – 2% = 6%).
- Year 3: Your payments reflect a 7% interest rate (8% – 1% = 7%).
- Year 4 onwards: Your monthly payments transition to the original 8% interest rate for the remaining loan term.
So, for as long as you own the home, or until you refinance to a new loan with a potentially lower interest rate, you will continue to make the principal and interest payment based on this 8% rate.
Temporary Buydown Calculator
Use our temporary buydown calculator to estimate the cost and potential savings associated with different buydown scenarios. We can also discuss if this makes financial sense for you any time!
Who Pays for a Temporary Buydown?
There are several ways to fund a temporary buydown:
- Seller/Builder Concession: Traditionally, sellers or builders will offer a temporary buydown as a seller concession to attract buyers, especially in a slow market.
- Buyer Funded Buydown: You can choose to pay for the buydown yourself at closing. This might be a good option if you have the savings and want to lock in lower monthly payments in the early years of your loan.
- Lender or Realtor Incentive: In some cases, lenders or real estate agents may offer a temporary buydown as part of a promotional package.
Funding and Cost Considerations
The party responsible for paying for the buydown pays the amount as a closing cost when the loan is funded. The amount is equal to the buyers interest savings. Meaning the difference between the final note rate and the agreed lower interest rate during the first years of the loan.
These funds are deposited into a custodial escrow account at closing. The loan servicer then draws from the account every month to make up the difference between the full loan payment and the discounted bill the homeowner is paying.
While both options involve lowering your interest rate, temporary and permanent buydowns have key differences:
- Reduction Amount: Temporary buydowns offer a more significant initial reduction (up to 3%) compared to permanent buydowns (typically 0.125% – 0.5%).
- Loan Structure: Temporary buydown funds are held in an escrow account and used to supplement your monthly payments. In a permanent buydown, the lender reduces the loan amount itself.
- Buyer Qualification: For a temporary buydown, you need to qualify for the full loan amount and original interest rate even though you’ll pay lower rates initially. Conversely, you only need to qualify for the reduced interest rate with a permanent buydown.
When is the best time to use a Temporary Buydown?
Temporary buydowns can be a good idea for first-time home buyers who are shocked by the speed at which mortgage rates have risen, and who will deplete their savings on the down payment and closing costs. The temporary payment reduction allows borrowers to replenish savings or spend the money on home upgrades.
The most favorable time to take advantage of a buydown is when the seller or builder is offering to contribute cash towards closing. Sometimes this can happen as an incentive to get a buyer to purchase their home or to encourage the purchase of a home in a newly built community. If this isn’t an option, a buyer can often still pay down the rate themselves.
Final Thoughts
Now that you understand temporary buydowns, it’s crucial to weigh the pros and cons against your individual financial situation and homebuying goals. Consulting with a mortgage professional is the best way to determine if a temporary buydown aligns with your needs. They can assess your eligibility, calculate potential costs and savings, and guide you through the entire mortgage process.
Beyond temporary buydowns, there are other strategies to navigate the homebuying journey in today’s market. Our team of home loan experts is dedicated to helping you explore all your options. Additionally, check out our blog for informative articles on various mortgage programs, down payment assistance, and tips for first-time homebuyers.
Let us empower you to make informed decisions and turn your dream of homeownership into reality. Contact us today to schedule a free consultation!
*Reduction in payment is the result of builder or seller concessions used to buy down the rate and are not guaranteed by NFM Lending. 5% down payment is the responsibility of the borrower. Available for fixed-rate conventional, VA, USDA, and FHA loans. For new or existing home purchases only.
These blogs are for informational purposes only. Make sure you understand the features associated with the loan program you choose, and that it meets your unique financial needs. Subject to Debt-to-Income and Underwriting requirements. This is not a credit decision or a commitment to lend. Eligibility is subject to completion of an application and verification of home ownership, occupancy, title, income, employment, credit, home value, collateral, and underwriting requirements. Not all programs are available in all areas. Offers may vary and are subject to change at any time without notice. Should you have any questions about the information provided, please contact us.