Buydown of Mortgage - Pay less interest

When someone's buying down your mortgage is typically what we're referring to is a seller or it could be a home builder or something like that, they're paying the lender happens to be to reduce the buyer's interest rate for a set period of time. Typically like the first three years, we might call it a 3-2-1 buydown mortgage. They also have 2-1 buydown mortgage.

In a 3-2-1 buydown, the seller would be paying so that the buyer has three percent less interest in year 1. 2 percent less interest in year 2, and one percent interest in year three. Then after that, it just reverts to the regular interest rate. So it's an incentive that the seller or the home builder is providing to the buyer in order to purchase the home. Now it doesn't always have to be a seller that is buying down the mortgage, it also could be the buyer who's buying down their own mortgage but typically we're more talking about a seller. 

Example of buydown mortgage

Let's say you want a home and you want to purchase it. So you go to the bank or your lender and you need to borrow $160000  @ 5.75% of interest rate because you want to purchase the home. Maybe the seller is having a hard time selling their home and they're not sure if you're gonna buy it or maybe you're having trouble qualifying for the loan at this interest rate. In any case, the seller decides to provide you with an incentive. They say "You know what I'm going to buy down your mortgage."So let's say they decide to give you a 3-2-1 buydown.

So what's going to happen is in year 1, the interest rate is going to be 2.75% for you, and in year 2, it's going to be 3.75%, in year 3, it's 4.75% and after year 3, it's just 5.75%. The way I got to that is, you take the 5.75% in year one and you subtract it by 3% points to get to 2.75%. So that's the interest rate you'll be charged in year one. You'll be charged it as if you had a thirty-year fixed-rate mortgage at 2.75%. That's how you'll determine your payment for that year. Then the seller is picking up the tab on the rest of the amount that it's is differing from this 5.75% payment. The sellers gonna pick that up that cost up and it's not the bank that's doing it.
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