Rate Buydown vs. Mortgage Points: What Sets Them Apart?
With mortgage interest rates currently higher than they have been in recent years, many buyers are exploring options that enable them to make a purchase while keeping their mortgage interest rate as low as possible. Two popular strategies that borrowers regularly consider are Temporary Rate Buydowns and Mortgage Points. These techniques can help lower your monthly mortgage payments, but they differ in their approach and application. Here we'll delve into the distinctions between a Temporary Rate Buydown vs. purchasing Mortgage Points.
Temporary Rate Buydown:
A Temporary Rate Buydown is a financing arrangement where a borrower or a seller pays upfront to reduce the interest rate on the mortgage for a predetermined period at the beginning of the loan. The primary objective is to make the initial years of homeownership more affordable, often with a plan to refinance before the buydown period ends. A recommended tactic is for buyers to request a seller subsidy as part of their offer (sometimes offering over list price in competative situations), and then using those funds toward the buydown.
An example is a 3-2-1 buydown. In this product the loan interest rate is reduced by 3% in the first year, 2% in the second year, and 1% in the third year. In this scenario a 7% mortgage rate would become 4% in year 1, 5% in year 2, and 6% in year 3, before returning to the regular rate of 7% for the remainder of the life of the loan.
Key features of a Temporary Rate Buydown:
1. Temporary Reduction: With a Temporary Rate Buydown, the interest rate on your mortgage is lowered temporarily, typically for the first few years of your loan term. This reduction results in lower monthly payments during the specified period, and is often one full point per year.
2. Upfront Costs: To secure a Temporary Rate Buydown, you, the seller, or even the lender may contribute by paying upfront costs. These upfront fees are invested in reducing the interest rate, making homeownership more accessible in the initial years.
3. Refinancing Benefits: If you decide to refinance your mortgage before the temporary rate reduction period expires, any unused portion of the Buydown can be applied directly to the mortgage principal. This can lead to a reduction in your outstanding loan balance.
Mortgage Points:
Mortgage Points, often referred to simply as "points," allow borrowers to pay upfront fees to their lender in exchange for a permanent reduction in the interest rate on their mortgage.
Key features of Mortgage Points:
1. Permanent Reduction: Purchasing Mortgage Points results in a permanent reduction of the interest rate over the life of the loan. Each point typically reduces the interest rate by around 0.25%.
2. Upfront Costs: Borrowers can choose to buy points, paying a percentage of the loan amount upfront to secure a lower interest rate. These points are not refundable. 1 point equals 1% of the loan amount.
3. Refinancing Considerations: If you refinance your mortgage before paying off the loan, any previously purchased Mortgage Points will not apply to the new mortgage. You will need to purchase new points, which can be a significant cost consideration.
Applying Unused Buydown to the Mortgage Principal:
One significant advantage of a Temporary Rate Buydown is the option to apply any unused portion to the mortgage principal during a refinance. Suppose you've been paying down your mortgage and have not fully utilized the Buydown when you decide to refinance. In that case, the remaining portion can be used to reduce your outstanding loan balance, potentially resulting in lower monthly payments or a faster path to mortgage payoff.
In contrast, Mortgage Points do not offer this flexibility. Once you've paid for Mortgage Points and secured a lower interest rate, the benefit remains tied to the original loan, and any refinancing requires purchasing new points if desired.
In Conclusion
Both Temporary Rate Buydowns and Mortgage Points are valuable strategies to reduce monthly mortgage payments, but they differ in terms of duration and flexibility. A Temporary Rate Buydown offers a temporary reduction in interest rates, with the unique benefit of applying any unused portion to the mortgage principal upon refinancing. Mortgage Points provide a permanent rate reduction but do not carry the same flexibility. When deciding between the two options, it's essential to consider your long-term homeownership plans and consult with a qualified mortgage professional to make an informed choice that aligns with your financial goals. Finally, it’s important to note, points and buydowns are not mutually exclusive of one another, and it’s possible to utilize both to reduce a mortage’s monthly payment amount.
Are you interested in learning how a buydown or points could aid in your own purchase? Feel free to reach out to be connected with phenomenal local lenders who will be able to explain the options further, and make suggestions for your specific situation.
