Buying Down Mortgage Interest Rates

An interest rate buy down is when the buyer pays interest points to the lender in order to secure a lower interest rate for a fixed period of time. The most frequently offered buy down is the 2 1 buy down. In this case, the buyer pays a one-time cash amount equal to 3 points more than the current interest rate in return for receiving a lower than market interest rate for the first two years of the loan. Once that two-year term expires, the interest rate reverts to the original rate in effect when the mortgage was issued.

Here’s an example:

Let’s say that the current interest rate for a conforming fixed-rate mortgage is at 8.5%. If the buyer is willing to make a payment of 1.5 points, they would receive an interest rate of 6.50% in the first year and 7.50% in the second year. From the third year on, the interest rate would be 8.50%.

Current trends in buy downs are a little bit different than the example above. More and more lenders are opting to increase the rate of the note rather than require the buyer to pay a large amount up front in points.

Here’s an example:

Let’s say again that the current rate for a conforming fixed rate loan is 8.50%. A 1.5 point payment would result in a first year buy down rate of 7.25%, a second year rate of 8.25%, and the remaining years would have a rate of 9.25%, instead of the 8.5% it would have otherwise carried.

Normally, the 3 2 1 buy down is another commonly offered alternative. It is essentially the same as the 2 1 buy down, but carries a 3% rate discount. A 3 2 1 buy down may also be offered as a flex fixed buy down where the interest rates increase every six months instead of once per year.

Here’s an example:

Let’s look at a flex fixed buy for 1.5 points on a jumbo loan. The rate for the first 6 months of the loan would be 8.00%. The rate would increase to 8.50% for the next six months. After that, the rate moves to 9.00% for the six months; 9.50% after that, and, at the 37th month, the rate would adjust to the original note rate of 9.875% for the remainder of the loan. A traditional buy down at 1.5% would lower the rate to just 8.875%.