What is a buy-down?
Buy-down refers to a reduction in the interest rate of a loan. This reduction is often compensated by a payment made when the loan is taken out, either by the borrower or the lender. This payment, when made by the buyer, is known as buying discount points. Discount point, also known as origination point or simply point, is the fee paid at the time of borrowing. One discount point is equivalent to one percentage of the loan amount. Buying one point can lower one’s interest rate by about 0.125% over the term of the loan, if it is a permanent buy-down. Most buy-downs are, however, temporary. The reduction in rate is applicable only for the first few years. 2/1 buy-down refers to a reduction in interest rate for the first two years of the loan. When the reduced rate is applicable for three years, it is known as a 3/2/1 buy-down. For example, if the interest rate for a loan is 9%, with a 3/2/1 buy down, the rate for the first year is 6%, for the next year it is 7%, and for the third year it
A buy-down feature of a loan is not the same as “buying down” the rate. Though similar sounding, they are entirely different. Buying down the rate refers to the common practice of paying discount points to obtain a rate lower rate than the listed rate. A “buy-down” is a temporary reduction in rate for a specified time. A 2/1 buy-down means the rate for the first year of the mortgage will be 2% less than the actual note rate, and the rate for the second year will be 1% less than the note rate. In the third year and subsequent years the borrower will pay the actual note rate. For example, a borrower with an 8% fixed rate loan with a 2/1 buy-down will have an interest rate of 6% the first year, 7% the second year, and 8% for all years thereafter. There are numerous combinations for buy-down options, but the most common are the 2/1 and the 3/2/1.
Buy-downs may be another way for the U.S. housing market to rebuild after the sub-prime mortgage meltdown of Summer 2007. Buy-downs work like this: The builder pays a lender a fee to lower the interest rate points on a home loan for a fixed amount of time – the buy-down. Typically, the rate drop will be a certain percentage for the first, second and sometimes third year. The cost savings for the home buyer from the buy-down can be equal several thousand dollars a year if done right. For home buyers, the boon in the buy-down is in the monthly payment for the introductory period rather than in the overall cost of the home. For instance, with a home loan of $150,000.00 and an interest rate of 6%, the home buyer could save over three thousand dollars the first year, over two thousand the second and a smaller amount the third. What’s more, the buy-down home buyer would qualify, with their debt to income ratio, for a higher priced home because of the first year monthly payments. If the home
