Achieve Your Goals Despite Rising Rates
Over the last two years, the Denver and Boulder real estate markets have seen unprecedented double-digit home appreciation. This pace was never sustainable and only negatively impacted average buyers and overall affordability.
The Federal Reserve Board is now trying to reduce inflation and slow housing appreciation by increasing interest rates. Of course, this has created quite a bit of stress for both house hunters and homeowners looking to go on the market.
As a buyer, you’re likely worried about affordability. If you’re a seller, you may wonder how rates will impact your returns. While rates are cyclical and will come down, there are tools available to help you now. Here, we’ll explain the Mortgage Rate Buydown options available to you.
What Is a Mortgage Rate Buydown?
This is a financing technique where a lump sum is paid upfront to temporarily (or permanently) reduce the interest rate, and thus lower monthly payments, during the early years of a loan.
A popular option is a 2-1 Buydown that provides a lower interest rate and thus, a lower mortgage payment, during the first two years of the loan term. The rate increases from one year to the next until it reaches its permanent rate in year three.
How Much Can a Buyer Save with a 2-1?
Based on a 30-year loan for $400,000 with a fixed interest rate of 5%, the buyer would pay an interest rate of 3% the first year, 4% the second year, and 5% from years 3-30.
At the original 5%, the buyer would have a payment of $2,147.29. Here are the savings from a 2-1 Buydown.
| Year | Interest Rate | Monthly Payment* | Monthly Savings | Annual Savings |
| 1 | 3% | $1,686.42 | $460.87 | $5,530.44 |
| 2 | 4% | $1,909.66 | $237.63 | $2,851.50 |
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| Total Savings | $8,381.94 |
*Principle and interest only.
Save More With a 3-2-1 Buydown
Similar to a 2-1, this provides deeper first-year savings and gives a buyer three years of lower rates. Based on a jumbo, 30-year loan for $925,000 with a fixed interest rate of 6%, the buyer would pay an interest rate of 3% the first year, 4% the second, 5% the third, and 6% after that.
With this larger loan at 6%, monthly payments would be $5,545.84. Here are the calculations.
| Year | Interest Rate | Monthly Payment* | Monthly Savings | Annual Savings |
| 1 | 3% | $3,899.84 | $1,646.00 | $19,752.00 |
| 2 | 4% | $4,416.09 | $1,129.75 | $13,557.00 |
| 3 | 5% | $4,965.60 | $580.24 | $6,962.88 |
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| Total Savings | $40,271.88 |
*Principle and interest only.
Pros and Cons to Consider First
Sellers Offering a Buydown
Potential Pros:
- Incentivizes and attracts more buyers
- Allows a buyer to qualify for a larger loan
- Increases likelihood of selling faster
- Can net more versus a price reduction
Potential Cons:
- Buydown fee must be paid at closing
- Reduced profit versus full price
Buyers Considering a Buydown
Potential Pros:
- May qualify for a higher loan amount
- More affordable payments at the start
- Seller can pay the buydown for you
- Offsets new home ownership costs
- Allows time for income increases
- Can possibly refinance without penalty
- More predictable than an ARM
Potential Cons:
- Seller may not be amenable to paying
- Income doesn’t keep pace with increases
The Permanent Mortgage Rate Buydown
Finally, there is the permanent buydown which would provide a lower rate for the full life of the loan. The final cost depends on how much the buyer borrows to purchase a home.
- Each Discount Point Costs 1% of the Loan Amount
- Each Discount Point Typically Buys a 0.25% Rate Reduction
So, if a qualified buyer is securing a 30-year mortgage loan for $400,000 with a fixed interest rate of 5%, paying $16,000 at closing would lower their interest rate to 4%.
The caveat here is the breakeven point—the amount of time it takes to recover the cost of buying the discount points. To find this figure, divide the discount point price by monthly savings.
Breakeven Point = (Price of Points) / (Monthly Savings)
So, with an interest rate of 4% instead of 5%, mortgage payments would decrease from $2,147.29 to $1,909.66 for a monthly savings of $237.63. Now, divide $16,000 by $237.63. That comes to about 67 months, or 5 years and 7 months, to recoup the cost of buying discount points.
As you can see, this makes sense when buying a forever home but perhaps, not when there are plans to move on in 2-5 years. In addition, the rate-reducing power of mortgage points depends on other factors such as the type of mortgage loan, so ask your agent or lender for details.
