How Does A “Buy-Down” Reduce Mortgage Interest Costs?
With a “buy-down” you have a below-market interest rate (it is “bought down”) because either the borrower or the seller have given additional money to the lender up front.
There are different forms of buy downs, most reduce interest costs in the first few years of the loan. For instance, if you pay an extra 1 point up front the interest rate might be reduced by .125 percent over 30 years, but perhaps by .25 percent for four years.
In a market where 30-year mortgages are available at 7 percent financing, with a “3,2,1 buy-down” the initial interest rate would be 5 percent in year one, 6 percent in year two, and 7 percent in year three and for the remainder of the loan term.
To see if a buydown is a good deal you must compare the reduced monthly cost with the payment up front and the interest you might have earned on the payment up front.
The best buydowns, of course, come from situations where sellers or builders pay up-front fees to lenders — and buyers get the lower rates.
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