The housing market unexpectedly flourished during 2020 and 2021, and with mortgage interest rates having doubled from more than a year ago, the demand for home buying still remains strong. Homeowners have been looking for ways to reduce their mortgage costs, and one tool they should consider is a permanent buydown. This method of mortgage financing allows borrowers to save money by paying upfront for a reduced interest rate over the life of the loan.
In this article, we’ll explore a permanent buydowns, how they work, and how they can help borrowers save money on their mortgage.
What is a Permanent Buydown?
When a borrower pays a lump sum upfront to permanently lower the interest rate on their mortgage for the entire duration of the loan, it is known as a permanent buydown. The money to fund the buydown may come from the borrower, the seller, or a third party like a builder.
Unlike temporary buydowns, which have an expiration date, the reduced interest rate remains the same and doesn’t increase over time. It’s worth noting that this type of buydown, the costs will vary based on the loan program you qualify for, your down payment amount, your loan amount and your credit score.
How a Permanent Buydown Works
If a borrower opts for a permanent buydown, the interest rate on their mortgage will be less than if they paid no points. The borrower pays a lump sum upfront at closing to lower the interest rate, and the reduced interest rate stays the same for the life of the loan. The borrower makes reduced mortgage payments throughout the life of the loan, resulting in long-term savings.
Choosing to buy down a mortgage for the entire loan term may require a larger amount compared to those who opt to buy down their mortgages temporarily for two or three years. For example, a buyer can decide to lower the interest rate on their $400,000 loan to 5.5% from 6% for the entire 30-year period. This would result in a monthly payment of $2,271 (P&I only), leading to an annual savings of $1,524 and a total savings of $45,720 over 30 years versus a 6% mortgage rate.
To estimate monthly payments based on different interest rates, potential buyers can take advantage of a monthly mortgage calculator.
How Much Does It Cost to Do a Permanent Buydown?
The cost of a permanent buydown will depend on several factors, but largest are usually the loan amount and how much the rate you choose is than the current without points. To lower your interest rate, you’ll need to pay a lump sum upfront at closing as part of your closing costs.
The interest rate on a permanent buydown is typically done in 0.125% rate increments. Buying down the rate 0.25% typically costs one percent or one point of the loan amount. For example, if you have a $400,000 loan amount, buying down the interest rate 0.25% from the current interest rate would be $4,000. However, there are often opportunities to buydown the rate for even less. These opportunities are often a result of market forces where mortgages are bought and sold as bundles on the secondary market. Don’t hesitate to ask your loan officer about these opportunities.
A permanent buydown reduces the interest rate for the entire life of the loan. If the original interest rate was 6% and you choose to buydown the rate 0.25%, the new interest rate would be 5.75%. Over the life of the loan, this could result in significant savings on interest charges.
It’s important to note that while the cost of the buydown may seem high, it can be worth it in the long run if you plan to stay in the home for a long time. It’s also important to factor in any potential tax benefits or deductions that may be available to you as a homeowner with a mortgage.
Let’s assume a 30-year fixed-rate mortgage of $400,000 at an original interest rate of 6%. The monthly principal and interest payment on this loan would be $2,398.
If you do a permanent buydown at a cost of two points ($8,000), the interest rate would be reduced by 0.5%, resulting in a new interest rate of 5.5%.
The monthly principal and interest payment at the new interest rate of 5.5% would be $2,271. This is a savings of $127 per month.
Over the life of the loan (30 years), the total savings in interest charges would be $45,720. And, you paid $8,000 upfront, leaving you a savings of $37,720.
So, even though the cost of the permanent buydown is relatively high in the beginning, the savings on interest charges over the life of the loan can be substantial.
Who Can Benefit from a Permanent Buydown?
A permanent buydown can benefit homeowners who plan on staying in their homes for a long time, as the long-term savings from the reduced interest rate outweigh the upfront cost. This financing technique can also help borrowers who want to lower their monthly mortgage payments or have a lower debt-to-income ratio. In addition, a permanent buydown can benefit home sellers who offer it as an incentive to attract potential buyers. A lower interest rate can make a property more affordable, increasing the likelihood of a sale.
Advantages and Disadvantages of a Permanent Buydown
A permanent buydown is a popular option for homebuyers who want to secure a low-interest rate for the entire duration of their mortgage. Here are some advantages and disadvantages of permanent buydowns:
- Long-term savings: By opting for a permanent buydown, you can lock in a low-interest rate for the entire duration of your mortgage, which can save you tens of thousands of dollars in interest payments over the years.
- Predictable payments: With a permanent buydown, you’ll have a fixed monthly payment for the life of your loan, which can make it easier to budget and plan for other expenses.
- Increased affordability: A lower interest rate can make it easier to qualify for a larger loan or make your monthly payments more manageable.
- Upfront costs: A permanent buydown requires an upfront payment that can be quite significant, which may not be feasible for all homebuyers.
- Opportunity cost: The money you use to buy down your interest rate could potentially be used for other investments or expenses, which may yield a better return.
- Selling your home: If you sell your home before the end of your mortgage term, you may not recoup the full cost of the buydown, which could result in a loss.
Overall, permanent buydowns can be a great option for homebuyers who want to secure a low-interest rate for the long term. However, it’s important to weigh the upfront costs against the potential long-term savings before making a decision.
How to Determine Whether a Permanent Buydown is Right for You: Factors to Consider
If you are considering a permanent buydown, there are several factors you should consider before making a decision. Here are some key factors to consider:
Length of Time You Plan to Stay in the Home
A permanent buydown is most beneficial to homeowners who plan on staying in their homes for a long time. If you plan on selling your home soon, the upfront cost of the buydown may not be worth it.
A permanent buydown can require a significant upfront cost, which can be difficult for some borrowers to afford. You should consider whether you have the funds available to pay the upfront cost.
Amount of Savings
You should calculate the total savings over the life of the loan to determine whether the upfront cost of the buydown is worth it. You can use a mortgage calculator to estimate your potential savings.
Other Investment Opportunities
You should consider whether the money you would use to buy down your interest rate could be better used elsewhere. For example, if you have other high-interest debt, it may be more beneficial to pay that off first.
Your Debt-to-Income Ratio
If your debt-to-income ratio is high, a lower interest rate may make your monthly mortgage payments more manageable.
Future Interest Rate Changes
You should consider whether interest rates are likely to increase in the future. If interest rates are expected to rise, a permanent buydown may be a good option to lock in a lower interest rate. If rates are projected to fall, a buydown now may not be the best choice.
Your Overall Financial Situation
Finally, you should consider your overall financial situation, including your income, savings, and credit score. A permanent buydown may not be the best option if you have other financial priorities or if you have a low credit score. Let’s consider if you’re going to get benefits out of a potential permanent buydown option with an example. One reason a permanent buydown may not be suitable is if you plan to move or refinance before the breakeven point. The breakeven point is the point at which the savings from the lower interest rate outweigh the upfront cost of the buydown. For example, let’s say you’re considering a permanent buydown that will cost $16,000 upfront and reduce your interest rate from 6.5% to 5.5%. Your monthly payment on a 30-year fixed mortgage of $400,000 would be reduced from $2,528 to $2,271, saving you $257 per month. To calculate the breakeven point, you would divide the upfront cost of the buydown ($16,000) by the monthly savings ($257), which equals 62.25 months or 5.2 years. This means that if you plan to move or refinance before 5.2 years, the buydown would not be worth it, as you would not have recouped the upfront cost. For instance, if you sell your home or refinance after two years, you would get paid $6,168 in total savings ($257 x 24 months) but would have paid $16,000 upfront. This would result in a net loss of $9,832 ($16,000 – $6,168), making the buydown not suitable in this case. By considering these factors, you can determine whether a permanent buydown is a right option for you. It’s important to carefully weigh the potential benefits and drawbacks before making a decision.
A permanent buydown is a powerful tool that can help borrowers save money on their mortgage payments. By paying a lump sum upfront, borrowers can reduce their interest rate over the life of the loan, resulting in long-term savings. Although a permanent buydown may increase upfront costs, it can lead to significant savings in the long run, making it a worthwhile option for those looking to reduce their mortgage costs.
Permanent Buydown Mortgage FAQs
Can I choose to buy down my interest rate at any time during the mortgage process?
It depends on the lender and the loan program. Some lenders may allow you to buy down your interest rate at any time during the mortgage process, while others may require you to do it at the time of closing.
Can I negotiate the terms of a permanent buydown with my lender?
Yes, you can negotiate the terms of a permanent buydown with your lender. You may be able to lower the cost of the buydown or adjust the interest rate reduction to better fit your financial needs.
How much can you buydown your interest rate?
There are no restrictions on the amount you can buydown your mortgage interest rate. However, it is best to consult with your loan officer about the factors above to ensure it is the best decision. In all buydown cases, the cost to buydown a rate will eventually exceed the benefit achieved.