What is a mortgage interest buyout?
When you decide to do so buy a houseyou commit to paying not only the purchase price of the home, but also the interest on your mortgage loan – the cost of borrowing money from your mortgage provider.
While interest rates have fallen in recent monthsmany home buyers are still looking for ways to make purchasing a home more affordable. And while it may be tempting to sit back and hope that mortgage rates continue to fall, that’s not guaranteed. That’s where buying up mortgage interest comes into play.
By paying a little more in advance, you can ensure lower security mortgage interest and keep more money in your pocket every month.
What is a mortgage buyout?
A “mortgage buyout” is a financing arrangement where the buyer, seller or builder pays mortgage pointsalso called discount points, at closing to obtain a lower interest rate. This one-time fee is paid at closing in exchange for a lower interest rate.
There are many ways to buy out a mortgage, depending on your lender and whether you want a permanent or temporary mortgage buyout.
Permanent versus temporary buydowns
A mortgage buyout can take place over a certain period or over the term of the loan.
Permanent mortgage buyout
With this option, you purchase a lower rate for the entire term of the loan from your lender via discount points. Unlike a temporary mortgage buyout, the interest rate will never increase.
Temporary mortgage buyout
With this scheme, your mortgage interest rate is reduced for a certain period before you return to the standard amount. You see structures for temporary mortgage purchases called, for example, a ‘3-2-1 buydown’ or a ‘2-1 buydown’. We will discuss what each arrangement looks like later.
How much does a mortgage buyout cost?
Each mortgage point a borrower pays is typically equal to 1% of the loan amount and typically lowers your interest rate by 0.25%. For example, one point would lower the mortgage interest rate from 6% to 5.75%. However, the amount each discount point reduces may vary by lender.
Example of a mortgage buyout
Suppose a mortgage lender offers you, the borrower, the option to reduce the interest rate by 0.25% in exchange for purchasing one point. So if the loan amount is $500,000 and the interest rate is 6%, the borrower can reduce their interest rate by one discount point to 5.75% by paying $5,000 (1% of $500,000) upfront.
When should you consider buying off your mortgage?
A mortgage buydown can be a smart strategy if your goal is to lower your monthly payments, especially in a high interest rate environment. But it is not suitable for every buyer. Whether a buyout makes sense depends on who pays for it, how long you plan to live in the home, and whether you want short- or long-term payment relief.
A mortgage buyout makes the most sense if:
A seller or builder pays for it.
This is the most attractive scenario for buyers. In a buyer’s market, sellers and homebuilders often offer interest rate buydowns as a concession to help move inventory. Because you benefit from a lower interest rate without paying the costs yourself, this is usually a profit.
You want a lower benefit in the first few years.
Many buyers use temporary buydowns, such as a 2-1 or 3-2-1 buydown, to make homeownership easier. This can be useful if your income is expected to increase, if you are adjusting to new housing costs, or if you want additional cash flow for moves and home improvements.
You plan to live in the house long enough to justify the upfront costs.
It generally only makes sense if you pay for the down payment yourself if you plan to live in the home long enough for your monthly savings to offset the cost of the discount points.
You buy when the interest rate is relatively high.
Buydowns are most popular when mortgage rates have increased and buyers are looking for ways to improve affordability without waiting for rates to drop.
When a mortgage buyout may not be a good fit
A buydown may not make sense if:
- You’ll be short on cash after you cover your down payment and closing costs
- You plan to sell or refinance in the near future
- You would rather use that money to increase your down payment
In some cases, putting extra money towards your down payment or keeping it in a savings account can offer more flexibility than locking it into discount points.
Types of mortgage purchases
There are three common arrangements for temporary mortgage purchases: the ‘3-2-1 buydown’, the ‘2-1 buydown’ and the ‘1-0 buydown’. Find out how each of these options work below:
What is a 3-2-1 buydown?
A 3-2-1 buydown allows the borrower to pay lower interest rates during the first three years of the loan. The first year the interest rate is three percentage points lower than the current interest rate, and for the following two years the interest rate increases by one percentage point every year. In the fourth year, the rate corresponds to the rate that you agreed upon at the start of your mortgage.
View the chart below to see how a 3-2-1 mortgage buydown would affect the buyer’s monthly mortgage payment on a $400,000 loan with a 30-year term and a 6% interest rate.
| Year | Interest | Monthly payment | Monthly savings | Annual savings |
|---|---|---|---|---|
| 1 | 3% | $1,686 | $712 | $8,544 |
| 2 | 4% | $1,910 | $488 | $5,856 |
| 3 | 5% | $2,147 | $251 | $3,012 |
| 4-30 | 6% | $2,398 | $0 | $0 |
The number of mortgage points charged for the buyout varies from lender to lender. However, you will find that the surrender charge is usually about the same amount the buyer will save in interest. Using the example above, the mortgage buyout cost approximately $17,412.
What is a 2-1 buydown?
A 2-1 mortgage buyout is similar to the 3-2-1 structure, except that the discounted interest rate only applies to the first two years of the loan term. This would give the buyer an interest rate 2% less than the standard rate in the first year and 1% less in the second year.
Using the same example above, taking a $400,000 loan with a 30-year term and a standard interest rate of 6%, let’s see how a 2-1 buydown would play out.
| Year | Interest | Monthly payment | Monthly savings | Annual savings |
|---|---|---|---|---|
| 1 | 4% | $1,910 | $488 | $5,856 |
| 2 | 5% | $2,147 | $251 | $3,012 |
| 3-30 | 6% | $2,398 | $0 | $0 |
In the first two years of the term, the buyer will save approximately $8,868 in interest. Knowing this, we can expect the cost of the 2-1 buydown to be about the same.
What is a 1-0 buydown?
A 1-0 buydown is a 1% reduction in interest rates in just the first year. Take a look at the diagram below to see how this structure plays out in a $400,000 loan with a 30-year term.
| Year | Interest | Monthly payment | Monthly savings | Annual savings |
|---|---|---|---|---|
| 1 | 5% | $2,147 | $251 | $3,012 |
| 2-30 | 6% | $2,398 | $0 | $0 |
Use one monthly mortgage calculator for an estimated monthly payment for varying interest rates.
Advantages and disadvantages of buying up mortgages
Under the right circumstances, a mortgage buyout can be a good option for both home buyers and sellers. Understanding your situation and being aware of the costs involved can help you avoid some of the potential pitfalls.
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Who pays for the redemption of a mortgage?
Although the buyer will ultimately benefit from a mortgage buyout, sellers and builders may also choose to purchase discount points to lower the interest rate for the buyer.
Cover the costs yourself
A mortgage buyout is typically negotiated between a buyer and their lender. If you have extra money after budgeting for your down payment, you can use that money to purchase mortgage points upfront in exchange for a lower interest rate.
Ask the seller to pay for it
If a seller needs to sell their house quickly or sell it in no time buyer’s marketthey can offer to pay for a mortgage interest buyout as an incentive to buy their home. If this is the case, the seller will make a one-time deposit deposit or pay points on the entire loan as part of the seller’s contract concessionsor the closing costs the seller has agreed to pay. This money gives the mortgage lender the money to lower the buyer’s interest rate, making it easier for them to pay for the home. However, the seller may attempt to match the mortgage buyout costs with the purchase price of the home to make up for the costs.
Use a builder closing cost incentive
Homebuilders can offer financial incentives for the purchase of their new-build homes. You can use the money to cover closing costs, including lowering your rate.
Use gift funds
If a family member or close friend has given you money, you can use this money to buy out the mortgage interest. However, there are limitations on the amount you can receive as a gift without receiving compensation gift tax.
Frequently asked questions about buying out mortgages
What are some alternatives to mortgage foreclosure?
Adjustable Rate Mortgages (ARM) And refinancing are potential options for people looking to save on their mortgage payments.
Please note that both depend on fluctuations in market interest rates. Refinancing is only worth it if interest rates fall, while an ARM can leave you on the hook for a higher payment if interest rates rise.
What are other ways to lower my interest rate?
If you want to reduce your interest costs without paying extra money up front, you can start by taking steps increase your credit score. A higher score can get you a lower interest rate on your mortgage, lowering your monthly payments.
Consult your mortgage provider
Make sure you work with your mortgage lender to find the best mortgage buyout arrangement for you, or whether a mortgage buyout makes sense at all for your situation.
Redfin does not provide legal, tax or financial advice. This article is for informational purposes only and is not a substitute for professional advice from a licensed attorney, tax professional, or financial advisor.
