The real estate boom has slowed and some potential sellers have had difficulty marketing their properties. With home prices higher and mortgage rates rising, homes have become less affordable for many potential buyers. Meanwhile, adjustable rate mortgages carry only slightly lower interest rates as compared to fixed rates and they come with the risk of rate adjustment in the future.

Today it may make a lot of sense to take a second look at an alternative that was not popular during the real estate boom, but has been used to spur home sales for decades. This current environment dictates a much closer look at temporary buydowns as a significant financing tool.

Many prospective home purchasers are finding that temporary buydown loans achieve lower payments during the first few years of their mortgage without experiencing the long-term risks of adjustables. Since the underlying mortgage of a temporary buydown is typically a fixed rate, there is no risk of longer-term rate increases. The fixed rate characteristic of the loan takes over after an early period of scheduled rate increases no greater than one percent each year.

The term buydown refers to lowering the rate of a mortgage. The term temporary buydown refers to lowering the mortgage’s rate for a specific period of time. For example, a temporary buydown of a six percent 30-year fixed rate mortgage might exist as follows:

We would refer to this example as a 1-0 (one-zero) buydown. It is so named because the interest rate is lowered, or bought down, one percent the first year and is not lowered in subsequent years. The most common temporary buydown presently available is a 2-1 (two-one) buydown–

6.0%  30-Year Fixed Rate

4.0% for the 1st year (payments 1-12)………………….2.0% buydown the 1st year
5.0% for the 2nd year (payments 13-24)……………….1.0% buydown the 2nd year
6.0% for the 3rd -30th year (payments 25-360)………..0% buydown 3rd-30th year

Why would someone choose a temporary buydown? Borrowers typically would look for a lower payment during the first few years of the mortgage term able to afford this home in the short run and if their income is expected to increase in later years, they will avoid the need for a second purchase in order to trade up.

In addition, with purchase and moving costs, the first few years of a mortgage are typically the most difficult to absorb. Higher payments may be easier to weather after the initial costs of homeownership are incurred.

What are the costs of a temporary buydown?

The lender will lower the payments on your mortgage for a few years by charging fees which are known as points. One point is equal to one percent of the loan amount — one point charged on a $100,000 mortgage would be equivalent to a cost of $1,000. The borrower may pay these points up-front in cash or this cost may be paid by the seller. The question remains—how much will this cost a borrower?

Calculating the costs of a temporary buydown is quite easy. The costs will be roughly the same as the benefits of lower payments received during the buydown period, unless there is a premium charged for the buydown. Another option for paying for the cost of a temporary buydown is asking the seller to pay the cost as a “concession.” It makes sense that a seller would be willing to pay the cost of a buydown. In essence, the seller is offering a lower rate and a more affordable payment on the home. This makes the home more attractive to potential buyers.

You certainly can see from the example that a seller would be much better off by offering a 2-1 buydown at a cost of approximately 2.25 points (or 2.25% of the loan amount), as opposed to lowering the value of the house. On a $300,000 home, the cost would be less than $7,000 while many are slashing prices by $30,000 or more!

Temporary buydowns of fixed rate mortgages are poised to be especially popular during the next few years. At present, the starting rates of adjustables are relatively high as compared to fixed rates. It should be noted that the costs of such a buydown may vary from lender to lender.