What are Interest Rate Buydowns and how do they work?

Temporary interest rate buydown explainer

“Interest rate buydowns” may be the official buzz phrase of the late 2022 sellers’ market. However temporary interest rate buydowns are actually a quite simple and interesting concept. Interest rate buydowns help home buyers afford a higher-priced home in the face of high interest rates. Buydowns temporarily lower mortage payments — even on fixed, 30 year mortgages.

Basically, the home seller “buys down” the interest rate as an incentive. Meaning, they pay to reduce it temporarily. The 3 – 2 – 1 refers to 3 years of mortgage payments. And of course 2 – 1 would refer to 2 years of payments.

For an even better explanation of Interest Rate Buydowns, look to the awesome JVM Lending blog. JVM is a respected lender in the Bay Area my clients have enjoyed working with, not only for their commitment to buyer education but because of their service.

Here’s what JVM founder Jay Voorhees has to say about temporary interest rate buydowns:

Temporary Buydowns = Escrow Account Created For The Buyer, Not Lender Fees

  1. Permanent Buydowns (aka points, origination fees, discount points, or lender fees): These are paid to permanently reduce a borrower’s interest rate by compensating a lender up front for the lost “rebate”, or lost commission, from selling a loan that contains a lower interest rate. So, permanent buydowns go directly into the lender’s pocket and can be paid by buyers or sellers. These are the buydowns that most of us are familiar with, and we generally advise buyers not to pay for them.
  2. Temporary Buydowns: $0 goes to the lender. 100% of the money goes to the buyer. A temporary buydown is literally (and I do mean literally) an escrow account set up by the sellers to pay the buyer’s mortgage down every month.

Read more in the JVM blog about how Temporary Buydowns are not at all ARMs (Adjustable Rate Mortgages).

(If you’d like an introduction to JVM for pre-approval, I’m happy to! Just ask. Note that I get nothing except your happiness when introducing you to lenders!)

Who benefits from temporary interest rate buydowns?

Home sellers benefit by attracting more buyers. On the other hand, they net less from the home sale: the interest rate buydown is subtracted from their sale proceeds.

Potential home buyers who may be attracted by several years of lower mortgage rates:

  • Future higher work income prospects: A buyer is new to the workforce and expects to have pay raises, or vest stock in the coming years, or switch jobs, or create another income stream.
  • Future combined incomes: A buyer is planning to have a partner or spouse or family / friends move in and share the living expenses, future, higher mortgage payments may be doable. And a lower mortgage payment for 3 years would be a boon.
  • House hackers who buy a fixer upper: Say you buy a duplex with plans to rent out one unit for extra income, but it’s not ready to rent when you buy it at a bargain price. It will be very helpful to have lower mortgage payments at first.

How can a home buyer get a temporary interest rate buydowns?

Your real estate agent can negotiate a temporary interest rate buydown. Sellers will be more likely to offer this if the home has been sitting on the market as an alternative (or perhaps in addition) to negotiating a lower selling price.

If your agent does not suggest an interest rate buydown, be sure to ask!

You’ll find plenty more on the Interwebs about temporary interest rate buydowns.

Any great lender should be happy to walk you not only through the details of buydowns but help you figure out what you can afford.

Video About Interest Rate Buydowns

Skip to 2:52 for an interview with Matt Sharp of Loan Depot for more on how temporary interest rate buydowns work.

Check out this article next

Halloween House Ideas From Stephen King's Maine Neighborhood

Halloween House Ideas From Stephen King's Maine Neighborhood

Add "trick or treat near Stephen King's house" to your bucket list. Then add "go to Bangor, Maine" to the list. That's where Stephen King's sprawling…

Read Article