Unlike Permanent Rate Buydowns, Temporary Rate Buydowns help homebuyer’s lower their interest rate and monthly mortgage payment for a short period of time at the front end of their home loan.
Mortgage Buydown (Temporary)
Home loan interest rate buydowns can be a great option for homebuyers. In general, the term “mortgage buydown” refers to paying up front costs that result in a lower interest rate. There are 2 types of mortgage buydowns:
- Temporary Rate Buydown
- Permanent Rate Buydown
Temporary rate buydowns are often referred to as “2-1 Buydowns”. The numbers “2” and the “1” stipulate how much the borrower’s interest rate is reduced during year 1 and year 2 of the loan.
For example, a borrower taking out a 30 year fixed mortgage at a 6% rate on a 2-1 buydown would have the following interest rates throughout the life of their loan:
- 1st Year: 4% (6% minus 2% = 4%)
- 2nd Year: 5% (6% minus 1% = 5%)
- 3rd Year through life of the loan: 6%
Temporary rate buydowns are available on select mortgage products only. Not all lenders offer temporary buydowns.
Benefits of Temporary Rate Buydowns
Borrower’s benefit from the savings Temporary Rate Buydowns create during the initial years of their loan. For the first 2 years of a 2-1 buydown a borrower pays a reduced monthly mortgage payment due to the temporarily reduced interest rates as noted above in our example.
Savings for the borrower can be substantial. For example, assume a buyer borrows $600,000 on a 30 year fixed Conventional home loan at 6% on a 2-1 temporary rate buydown. Their savings would look like this:
- Year 1: $7,328 saved
- Year 2: $3,763 saved
- Total Savings: $11,091 saved (Yr 1 + Yr 2)
In year 1, the borrower saves $7,328 due to their temporarily reduced 4% rate (instead of the full 6%).
In year 2, the borrower saves $3,762 due to their temporarily reduced 5% rate (instead of the full 6%).
From year 3 until the end of the loan this sample borrower’s rate would be 6%.
What Do Temporary Rate Buydowns Cost?
First, buyers cannot pay for the temporary rate buydown cost themselves. The cost is paid for by a seller, realtor or other acceptable party. The most common payor is the seller or builder of a new home.
The cost of a Temporary Rate Buydown is the exact same as the borrower’s savings. Using the example above, the borrower saved $11,091 in interest during year 1 and 2. Therefore the cost of that buydown also equals $11,091.
In other words, a seller/builder/realtor party pays $11,091 for the sample borrower above to get the 2-1 buydown. The buydown costs are paid to the borrower’s originating lender at the time of loan closing.