How Does a Buy-Down Mortgage Work?
- Home buyers, home builders and those looking to sell a property can use buy-down mortgage financing as a way to make a home purchase more affordable during the first few years of the loan. In effect, buy-down financing restructures a loan amount to suit buyers who expect their income to increase in future years, but can't afford high mortgage payments at the current time. This option may suit buyers, such as a young couple or college graduates, just starting out in the job market or in cases where a spouse is returning to work. By using a buy-down option, mortgage payment costs are reduced during the first few years of the mortgage, which may allow buyers to purchase a larger home or a home located in a better area.
- Buy-down mortgages involve adjusting the interest rate on a mortgage loan by pre-paying a specified amount of interest at the outset. Someone selling a home could opt to buy-down or pay for a certain percentage of the interest rate in order to reduce the amount of mortgage payments a buyer pays during the first few years of the loan. Interest rate percentages --- also known as loan points --- are calculated as mortgage fees, with each fee or percentage equal to 1 percent of the total loan amount, according to Bankrate.com, a personal finance reference site. So, if a seller pays for one point, he can reduce the total mortgage loan amount by 1 percent, which comes out to $1,000 on a 30-year, $100,000 mortgage. This discount is then applied toward the first few years of the mortgage loan, which allows for a lower mortgage payment at the outset of the loan term. In effect, a buyer ends up paying less in mortgage payments during the first few years of the loan, which gives her time to increase her income earning capacity.
- Buy-down mortgage loans come in two different forms, known as the 3-2-1 buy-down and the 2-1 buy-down. The 3-2-1 buy-down loan requires the seller to pre-pay the interest on the first three years of the loan. In effect, the seller pre-pays 3 loan points for the first year, 2 loan points for the second year and one loan point for the third year. By the fourth year of the loan, the buyer pays the full market rate on the monthly mortgage payment. The 2-1 buy-down works in much the same way except the seller pre-pays on two years worth of loan points instead of three. In effect, the buy-down offer allows sellers to lower the purchase of a property while at the same time making it more affordable for the buyer to take on the loan obligation.
- Home buyers --- as well as sellers --- can opt to buy-down the first three (or two) years of interest on a mortgage loan. Of course buyers will have to prepay these costs, just like a seller would, meaning the buyer pays a portion of interest costs upfront along with any down payment amount and closing fees. Buyers who intend to stay in their homes for a number of years may opt for a buy-down mortgage, especially in cases where an increase in income earnings is expected. In effect, buyers end up paying the money saved in interest for the first three years ahead of time. Whether the buyer or the seller prepays on a buy-down mortgage, the buyer always faces the possible risk of not being able to afford the monthly mortgage payment increase once the interest rate goes up in the third or fourth year of the loan.
