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Paying an upfront fee to lower your mortgage interest rate, known as a mortgage rate buydown, can lead to significant long-term savings if you plan to stay in your home for an extended period. This strategy involves purchasing discount points at closing to secure a permanently reduced rate. The key to determining if a buydown is right for you lies in calculating your breakeven point—the time it takes for monthly savings to exceed the initial cost. For homeowners with a long-term horizon, this can be a financially sound decision.
What is a mortgage rate buydown?
A mortgage rate buydown is a financing strategy where a borrower pays an upfront fee to reduce the interest rate on their home loan for its entire term. This fee is paid in the form of discount points. One discount point typically costs 1% of your total loan amount and may lower your interest rate by approximately 0.25%, though the exact reduction depends on the lender and market conditions.
When does a mortgage buydown make financial sense?
A buydown is not a one-size-fits-all solution. Based on our experience assessment, it is most advantageous under specific circumstances.
You are a long-term homeowner. The primary factor is your planned tenure in the home. You must stay beyond the breakeven point to realize the savings. If you sell or refinance too soon, you will not recoup the upfront investment. Interest rates are elevated. When market rates are high, buying down your rate can provide immediate relief and long-term savings compared to accepting the prevailing rate. You have sufficient liquid cash. You should have cash reserves beyond your down payment and closing costs. Using funds earmarked for emergency savings or essential home repairs is not advisable.
How to calculate your breakeven point on a mortgage buydown
The most critical step is calculating your breakeven point. This tells you how long you need to keep the mortgage to make the upfront cost worthwhile.
Use this formula: Total cost of points ÷ Monthly savings = Breakeven point (in months)
Consider the following hypothetical data based on a $400,000 loan:
| Scenario | Original Rate | Rate After 1 Point | Upfront Cost | Monthly Savings | Breakeven Point |
|---|---|---|---|---|---|
| Example A | 7.00% | 6.75% | $4,000 | $98 | ~41 months |
| Example B | 6.50% | 6.25% | $4,000 | $92 | ~43 months |
Note: Calculations are estimates. Actual figures will vary.
If your breakeven point is 40 months (about 3.5 years), you should plan to own the home for at least that long for the buydown to be beneficial.
What are the different types of mortgage buydowns?
There are two primary structures: temporary and permanent.
What is a temporary buydown? A temporary buydown lowers your interest rate for the initial years of the loan. A common structure is a 2-1 buydown, where the rate is reduced by 2% in the first year and 1% in the second year before returning to the original note rate for the remainder of the loan. This can be helpful if you expect your income to increase soon. What is a permanent buydown? A permanent buydown, achieved by purchasing discount points, lowers your interest rate for the entire loan term. This is the standard option for buyers seeking stable, long-term savings.
What are the potential drawbacks of a mortgage buydown?
The main disadvantage is the high upfront cost, which increases your cash needed at closing. There is also a risk of not reaching the breakeven point if you move or refinance earlier than anticipated. Furthermore, in a competitive market, requesting that a seller pay for a buydown could weaken your purchase offer.
Key considerations before buying down your rate
Evaluate your financial timeline. Your planned duration of homeownership is the most critical factor. Explore payment options. You can pay for points out-of-pocket, or in some cases, negotiate for the seller to contribute to the cost. Consult with a mortgage professional. A lender can provide precise breakeven calculations based on your specific loan scenario.
In summary, a mortgage rate buydown is a strategic tool for long-term homeowners seeking to reduce their total interest paid. The decision hinges on a clear understanding of your breakeven point and financial goals. Calculate your breakeven carefully and discuss all options with your lender to determine if this strategy aligns with your homeownership plans.
