What’s a mortgage fee buydown and the way does it work?

What are temporary purchases?

A temporary buydown lowers the interest rate by a certain percentage, which then increases each year until it returns to the base rate. Common temporary buydown terms are 2-1 and 1-0, where the first number is the rate reduction you will receive in year one and the second number is the rate reduction for year two.

With a 2-1 buyout, the 6.25% mortgage rate will drop to 4.25% in the first year, increase to 5.25% in the second year, and return to 6.25% in the third year. Here’s what it looks like for a loan balance of $350,000.

When you’re shopping for a mortgage, it’s essential to understand how discount points and rate buydowns work. A lender may offer an exceptionally low rate, just to build a discount fee into the deal. That’s why you’ll want to look at all aspects of the loan, not just the rate.

“Hardcore rate shoppers, they place zero value on service, expertise, education, they’re just so focused that often they end up with the worst deal,” Beeston says.

A temporary purchase may make sense because the buyer is not paying for it. However, even in that scenario, purchases can be made at the cost of other seller concessions. So you might want to consider the tradeoff by asking yourself these three questions:

1. Can you refinance later and get the same rate?

Whether or not you can refinance depends on several factors, including the type of mortgage.

For conventional loans, you’ll need at least 5% equity (loan-to-value of 95%) for a rate and term refinance, but you’ll typically get the best rates if you have 20% equity in your home or More. There are still very few cases where lowering the rate makes sense, says Beeston. However, if the borrower took out a conventional loan with as little as 3%, “I think it makes sense because if rates drop, they won’t have enough equity to refinance right away.”

There are streamlined refinance options for both FHA and VA loans, which can make refinancing with these loans simpler than with a conventional loan. So paying a low rate makes little sense for these types of borrowers. “The last thing I want is my veterans spending a nickel to lower a rate that has the potential to be refinanced next year because then it’s just setting money on fire,” she says. She says

You will need to consider upfront closing costs each time you refinance. Your exact closing costs vary depending on the lender, the loan, where you live and the amount you’re borrowing. But refinancing fees average thousands of dollars and can easily wipe out any potential savings you may have gained by securing a lower rate.

However, you may be able to negotiate with the lender to obtain credit to cover your fees in exchange for a higher interest rate. Lender credits are essentially reverse discount points and you may be able to use them to avoid fees when you refinance.

2. What are you giving up for buydown?

The housing market has shifted recently and sellers are trying hard to woo buyers. “Because of the market, we are encouraging our clients to pay the closing costs from the seller, and we’ve had really good success,” says Beeston.

Just keep in mind that when sellers offer to buy, that money has to come from somewhere. And funding the buyout may come at a cost to the seller, reducing the overall purchase price or paying closing costs. Depending on your priorities and financial situation, those concessions may be more important to you than the buydown.

3. Is this a good deal without discount?

With any type of buydown or discount point, you’ll want to make sure the starting rate is a good deal. Always compare loan offers from multiple lenders to make sure any discount is based on the best deal you can qualify for.

“one never gets [quote] Because the industry can operate like a bad flea market,” says Miller. And be wary of any lender that’s willing to price match because, “Oh, I think you called someone else and found out.” that I was charging too much. Ok. I met. I’ll match it,” says Miller.

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 your home loan and home buying process in general. You’ll want to pay attention to the closing costs of your mortgage because the fees you pay can wipe out the potential savings from securing a lower mortgage rate.

If you’re considering taking advantage of rate buydowns or discount points, be sure you fully understand what you’re getting, what it’s worth and what you might have to pay to get it.