If you are trying to determine if a temporary buydown is a good option for you on your next home purchase, but you do not know what a temporary buydown is or do not fully understand it, we are here to help. Below is some basic information about a temporary buydown: what it is, how it works, and how it might benefit you.

A temporary buydown is a mortgage financing arrangement that involves an upfront payment made to the lender, usually form the seller or builder, in exchange for a reduced interest rate on the loan for a specific period, usually one to three years. This arrangement is designed to make homeownership more affordable during the early years of the mortgage.

Here's how temporary buydowns work:

Agreement to the Buydown

The builder or seller offers to cover the upfront payment associated with the temporary buydown to help incentivize homebuyers in the purchase. The builder / seller pays the lender the required amount at closing on behalf of the borrower. These funds go in a special account that is used to subsidize the borrower’s monthly mortgage payments.

Reduced Interest Rate

In return for the upfront payment, the lender agrees to lower the interest rate on the mortgage for a predetermined period, typically 1 to 3 years. The reduced interest rate will be calculated depending on the type of buydown selected. The lowered interest rate provides the borrower with more affordable monthly mortgage payments during the buydown period.

Gradual Increase

Following the temporary buydown period, the interest rate gradually increases according to the agreed-upon terms until it reaches the original rate stated in the mortgage note signed at closing. The gradual increase ensures a smooth transition to the regular interest rate, as the borrower's financial circumstances are expected to stabilize.

The full details of the increase will be disclosed to the borrower so they can plan appropriately.

As an example, if the builder and borrower agreed to a “2/1” buydown, the rate would decrease by two points in year one, one point in year two, and then would be the full interest rate by year three. So if the agreed upon interest rate on the mortgage note is 6.5%, it would decrease to 4.5% for the first year, 5.5% for the second year, and then stabilize at 6.5% from the third year onwards.

Lower Monthly Payments

Thanks to the reduced interest rate during the buydown period, the borrower enjoys lower monthly mortgage payments. While the full payment is due every month, the subsidy account created at closing pays a portion of the monthly payment. This can make homeownership more manageable, especially during the initial years when expenses may be higher due to moving costs or other related expenses.

Long-Term Impact

While the builder or seller covers the upfront payment, it's important to note that the borrower will eventually pay the full interest rate on the mortgage once the temporary buydown period ends. As with any buydown arrangement, the financial benefits are spread out over the life of the loan. It's essential for borrowers to consider the long-term implications and ensure they can comfortably afford the mortgage payments when the interest rate returns to its original level.

Temporary buydowns can be beneficial for certain homebuyers, such as those with limited initial funds or individuals who anticipate a significant increase in income. However, it's essential to carefully evaluate the financial implications, including the upfront costs, the length of the buydown period, and the potential long-term expenses, to determine if it aligns with your specific circumstances and financial goals. Consulting with one of Leaders’ mortgage champions can provide further guidance tailored to your specific situation.