Rising mortgage rates have pushed potential home buyers to the sidelines and slowed home sales. In an effort to simulate a sluggish market, sellers and mortgage lenders have begun to entice prospective homeowners with price buys and discount points that make home loans more affordable for buyers.
“These products already exist and are typically only used when lenders are desperate to meet consumer needs,” said Gordon Miller, president of North Carolina-based Miller Lending Group.
So before you use the buydown price or discount points to lower the interest rate on your mortgage, it is important to understand how they work and when it makes sense for you.
How do you buy down mortgage rates?
Buydowns and discount points (known as mortgage points) are two ways to lower the mortgage interest rate by paying extra money when taking out mor. These terms are sometimes used interchangeably, so it’s important to understand how individual mortgage lenders define buydown. “Make sure you get a copy [mortgage] own notes. So that’s it [way] you understand all the terms and/or limitations of the buydown,” Miller said.
What is the discount point?
When you pay a discount or mortgage points, you permanently reduce the mortgage interest rate (as opposed to buydowns which only temporarily lower rates).
You will generally pay 1% of the loan amount for each point and receive a 0.25% rate reduction, but fees and discounts vary by market and lender. “What you get with one point from one lender can be different from another lender,” he said Jennifer Beeston, mortgage educator and senior vice president at Guaranteed Rates.
Are buydowns temporary?
A buydown temporarily lowers the interest rate to a certain percentage, which then increases every year until it returns to the original level. Common temporary buydown terms are 2-1 and 1-0, where the first number is the rate reduction received in the first year and the second is the rate reduction for the second year.
With a 2-1 buydown, the 6.25% mortgage rate would be cut to 4.25% in the first year, rising to 5.25% in the second year and returning to 6.25% in the third year. Here’s what it looks like for a $350,000 loan balance.
An example of buying a mortgage
| interest rate | Monthly payments | monthly savings | annual savings | |
|---|---|---|---|---|
| year 1 | 4.25% | $1,722 | $433 | $5,196 |
| Year 2 | 5.25% | $1,933 | $222 | $2,664 |
| Year 3 | 6.25% | $2,155 | $0 | $0 |
A temporary buydown is usually paid by either the seller, the homebuilder or the lender and effectively balances the part of the buyer’s monthly payment. From the example above, it would cost $7,860 to buy a full 2-1, which is the total amount the buyer saves. The money used to lower the buyer’s monthly payment is deposited into an account and taken monthly by the mortgage lender. Remember, with a buydown, the borrower must qualify for a full interest rate-based home loan after the buydown expires.
Regardless of whether or not shopping is the right price for your situation, you want to make sure you’re getting the best deal from the start. And if you don’t compare offers from different mortgage lenders, there’s a good chance you’ll be leaving money on the table. Choose the lenders ranked below as some of the best mortgage lenders on the market:
Rocket Mortgage
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Annual Percentage Rate (APR)
Apply online for private rates
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Types of loans
Conventional loans, FHA loans, VA loans and Jumbo loans
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Requirements
8 – 29 years, including terms of 15 years and 30 years
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Credit is required
Usually requires a credit score of 620 but will consider applicants with a credit score of 580 as long as other eligibility criteria are met
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Minimum down payment
3.5% if advanced with an FHA loan
SoFi
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Annual Percentage Rate (APR)
Apply online for special rates; Fixed and adjustable rate mortgages included
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Types of loans
Conventional loans, jumbo loans, HELOCs
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Requirements
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Credit is required
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Minimum down payment
Pros
- Quick pre-qualification
- Provide access to Mortgage Loan Officers for guidance
- $500 off for SoFi members on Friday
- 0.25% price reduction when you lock in a 30-year rate on a conventional loan
- Offers $9,500 cash back when you buy a home through SoFi Real Estate Center
Cons
- Does not offer FHA, VA or USDA loans
- Mortgage loans are not available in Hawaii
Ally Bank Mortgage
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Annual Percentage Rate (APR)
Apply online for special rates; Fixed and adjustable rate mortgages included
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Types of loans
Conventional loans, HomeReady loans and Jumbo loans
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Requirements
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Credit is required
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Minimum down payment
3% if advanced with a HomeReady loan
Pros
- Ally HomeReady loans allow for a slightly smaller down payment at 3%
- Pre-approved in just three minutes
- Application submission takes only 15 minutes
- Online support is available
- Existing Ally customers can receive discounts that will be applied to closing costs
- No lender fees
Cons
- We do not offer FHA loans, USDA loans, VA loans or HELOCs
- Mortgage loans are not available in Hawaii, Nevada, New Hampshire, or New York
What you need to know before shopping for a lower mortgage rate
Find out how discount points and purchase prices work when you’re shopping for a mortgage. Lenders can offer very low rates, simply by having a discount fee built into the deal. So, you want to pay attention to all aspects of the loan, not just the rate.
“Hardcore level buyers, they give zero value to service, expertise, education, they only focus on the level that often gives the worst deal,” Beeston said.
If you’re paying for a discount, it’s important to always know what you’re getting. Paying a lower rate over a 30-year loan term may seem like it will save you money in the long run, but it doesn’t reflect how likely you are to sell your home. repay the loan or pay off the mortgage early. In each of these cases, the cost you pay up front may be higher than what you save. And researchers have shown that “borrowers overestimate how long they will stay with the mortgage.”
A temporary buydown can make sense because the buyer is not the one paying. However, even in that scenario, the buydown can be done at the expense of another seller’s concession. So you’ll want to consider the tradeoffs by asking yourself these three questions:
1. Can you get the same rate by refinancing later?
Whether you can refinance depends on several factors, including the type of mortgage.
For a conventional loan, you need at least 5% equity (95% loan-to-value) for the rate and term, but you’ll only get the best rate if you have 20% equity in your home or something else. Now, there are few cases where it can be bought down, Beeston said. However, if the borrower takes out a conventional loan with 3% down, “I think it can make sense because if the rate goes down they likely don’t have enough capital to refinance immediately.”
There are flexible refinancing options for both FHA and VA loans, which can make refinancing easier with these loans than with conventional loans. So it may make less sense for this type of borrower to pay a lower rate. “The last thing I want is veterans spending a nickel to buy a rate that will be refinanced next year because it’s just a waste of money,” he said.
Every time you refinance you need to consider upfront closing costs. Exact closing costs vary depending on the lender, the loan, where you live and the amount you owe. But the average cost of a refinance is thousands of dollars and can easily wipe out the potential savings you get by securing a lower rate.
However, you may be able to negotiate with your lender to accept credit to cover your costs in exchange for a higher interest rate. Lender’s credit is a reverse discount point and you can use it to avoid costs when you repay.
2. Are you giving it up to buy it?
Recently the housing market has changed and sellers are working hard to entice buyers. “Because of the market, we’ve encouraged our clients to have sellers pay the closing costs, and we’ve had great success,” Beeston said.
Remember that when a seller offers to buy, the money has to come from somewhere. And buydown financing can come at the expense of the seller reducing the overall purchase price or paying for closing costs. Depending on your preferences and financial situation, the concession may be more important to you than the purchase.
3. Is this a good deal without a discount?
With any point of purchase or discount, you want to make sure that the starting rate is good. Always compare loan offers from different lenders to ensure that the discount is based on the best offer you can get.
“Didn’t get one [quote] because the industry can operate like a bad flea market, “says Miller. And beware of any lender who is willing to price match because, “that’s more of a game than, Oh, I guess you call someone else and know I’m charging. too much. Yes. get me I’ll fit right in,” Miller said.
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With mortgage rates sitting at double what they were a year ago, it can be tempting to do everything in your power to get a lower rate. But your interest rate is only one aspect of the home loan and home buying process in general. You’ll want to pay close attention to your mortgage closing costs because the fees you pay can wipe out the potential savings from securing a lower mortgage rate.
If you’re considering taking advantage of a rate buydown or discount point, make sure you fully understand what you’re getting, what it costs and what you have to give up to get it.
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Editorial Note: Opinions, analysis, reviews or recommendations written in this article are only those of the Select editorial staff, and have not been reviewed, approved or endorsed by a third party.