What does it mean to buy down a mortgage?
A mortgage buy down is a real estate transaction between the seller and/or homebuilder and the buyer to facilitate the sale of the home. A purchaser buys down a mortgage by tendering a higher original payment to the lender in order to decrease the interest rate for a specific period of time. In other words, a mortgage buy down is an initial lump-sum payment, which enables the lender to lower the interest rate for a given duration on a fixed rate mortgage. Payments may increase at the conclusion of the stated time period.
The mechanics of this mortgage-financing technique are straightforward. The borrower pays discount points to the lender up front to obtain a lower interest rate for the first few years of the mortgage (usually one to three years), but possibly its entire duration. The builder and/or seller of the home typically provides payments to the mortgage-lending institution. The lending institution, in turn, lowers the purchaser's monthly interest rate on the mortgage and charges a lower monthly payment. The price of the home is increased to compensate the home seller for the costs of the buy down arrangement.
An interest rate buy down can be easily understood in terms of a subsidy on a fixed mortgage made to the home purchaser on behalf of the seller. The subsidy is a fund that the seller contributes to an escrow account. This fund is used to help pay the loan during the first few years, thereby enabling the buyer to take advantage of a lower monthly payment. This lower payment assists the home buyer in qualifying more easily for the loan. Thus, a buy down appeals to borrowers who believe that they will be able to afford a larger home payment in several years, but are not yet ready to make monthly payments at the higher current mortgage rate. This finance plan provides an incentive for the borrower to purchase the property.
There are two types of buy down mortgages. A temporary buy down mortgage is one in which a payment is made to reduce the borrower's monthly payments during the first few years of a mortgage. After the first few years and for the remainder of the term, the borrower must pay the original note rate. A permanent buy down is an up-front payment that reduces the interest rate over the life time of a mortgage.