I’ve Been Writing About Real Estate for 8 Years — And Even I Didn’t Know About this Money-Saving Loophole

published Sep 11, 2024
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Couple planning their future home
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When I was scrolling listings for new homes to buy in the Denver-metro area, I came across several that advertised “temporary interest rate buydowns” that would be paid by the seller or builder. I had a pretty solid understanding of buydowns, but mostly as they pertained to buying points or negotiating the deal with your lender. But temporary interest rate buydowns, I had never heard of — even though I consider myself a real estate expert.

What are mortgage buydowns? 

There are two categories of buydowns: temporary and permanent, explains Brian Quigley, the founder at Beacon Lending. In a temporary buydown, the rate is reduced for a few years before returning to the standard rate, which can ease you into higher payments, Quigley says. 

A permanent buydown reduces the rate for the life of the loan. This can be a smart move if you have the cash up front and plan to stay in the home long-term, as the savings over time can outweigh the initial cost, he says.

What are temporary buydowns, and how do they work?

In a nutshell, temporary buydowns typically make your mortgage payments more affordable for the first one to three years of your mortgage. 

One thing that surprised me: These types of temporary buydowns are often used to sweeten the deal for buyers who may otherwise be on the home-buying sidelines, waiting for rates to drop before putting in offers, explains Khwan Hathai, CFP, with Epiphany Financial Therapy.

Despite hearing a lot of buzz about temporary buydowns, I didn’t quite understand the mechanics of them until recently.

If you negotiate a temporary buydown when buying a home, the money gets put into your escrow account and a portion is applied to your loan every month during the buydown period, essentially pulling down your interest rate. I had the misperception that this was a “use it or lose it” type of scenario, so I was surprised (and delighted!) to find out that if you refinance or sell your home during the buydown period, any of the funds you didn’t use from your buydown gets applied to your home loan, reducing the balance.

So, for example, we negotiated a 1% buydown in the first year of our mortgage. We’re paying 5.99% this year and our interest rate is set to jump up to 6.99% in a year. The buydown saves us about $500 a month on our mortgage, or $6,000 a year. However, we also negotiated one free refinance with our lender, which means if rates drop (and mortgage forecasters predict they will), and we refinance, the cash that was stashed in our escrow to buy down our mortgage will instead reduce our loan balance. 

By the time we refinance, we probably won’t have much time remaining on our buydown. But one of my girlfriends has a 3-2-1 buydown that she negotiated with the seller of her home when interest rates were above 7% in 2023. This means her interest rate is reduced by 3% in the first year, 2% in the second, and 1% in the third and final year. She’ll likely refinance before the third year and will have a nice stack of cash in her escrow to reduce her loan even further.

Buydowns were also a big part of both my buying and selling strategy. After a couple of weeks on the market, instead of dropping the price on my home, I offered a buydown to buyers that would amount to about $12,500. The sellers who bought my fiancé’s house also negotiated a buydown. 

So you might be curious: Why not just negotiate a lower price instead of a buydown? Typically, buyers favor buydowns because it equates to a lower monthly payment, giving them more cash flow in the first few years of their mortgage, which can help offset costs like moving or needed repairs.

A final word of caution: Temporary buydowns are only a good idea if you’re confident you’ll be able to pay your mortgage if and when the interest rate goes up.