With home mortgage rates rising, it has become increasingly common for home sellers to explore options that make their houses more affordable. To do this, they may offer to “buy down” the interest rate on behalf of the buyer’s mortgage loan to help reduce the cost of a new mortgage loan for a year or two.
Historically, when a mortgage loan rate is reduced, it’s done through the buyer’s direct purchase of “points.” But in this case, a “buy-down” is a different approach. To decide which path to mortgaging is right for you, let’s look at each of these options in a bit more detail.
What are mortgage points?
A point i a fee paid to the lender in exchange for a lower interest rate on a mortgage loan. One point is equal to 1% of the loan amount. So, if you are taking out a $500,000 mortgage, one point would be $5,000. Points are typically paid at closing, but in some cases, they may be included in the loan itself and paid over time.
There are two types of points: discount points and origination points. Discount points are paid in exchange for a lower interest rate on the loan. When a home seller offers to pay for points on behalf of the buyer, they usually refer to discount points. On the other hand, origination points are fees charged by the lender for processing the loan. These are often put towards the total overhead costs of the loan.
How is a rate buy-down different from traditional points?
Rate buy-downs carry a few similarities to the traditional points system. Both can reduce the interest rate on a mortgage loan and make the total cost of home ownership more accessible to new buyers. However, rate buy-downs typically apply for a much shorter period than paying points. For example, when a home seller offers a buy-down for a buyer, it typically reduces the interest rate for only one or two years of the loan, not the life of the loan, as with the points system.
The rate buy-down process, however, is less expensive than paying points and can save the buyer money for a few years. Often, homeowners take advantage of a buy-down, assuming that rates will eventually go back down, and they can refinance later at a lower rate. Or, when the rate buy-down expires, the new homeowner will have had two more years of employment and earn more income, so they can easily absorb the increase in the monthly payment amount.
How does a seller benefit from a buy-down?
Now that you know the difference, you might wonder why a seller would offer this to someone buying their home. There are a few reasons this might happen.
First, it can be a way to make the home more attractive to potential buyers. If a buyer is on the fence about purchasing a particular home, the seller may offer to buy down the rate for a year or two. Depending on the sale amount (and the seller’s motivation), they may even offer to pay actual points as an incentive to close the deal.
Second, buying down the rate or paying points can be a way for the seller to negotiate a higher sale price. If the seller is willing to pay points to help the buyer get a lower interest rate, the buyer may be willing to pay a higher price for the home.
Finally, buying down a rate or paying points can be a way for the seller to help the buyer afford the home. If the buyer struggles to qualify for a mortgage due to a high-interest rate, the seller may offer to pay points to help lower the rate and make the loan more affordable.
Are there any drawbacks to a rate buy-down or paying points?
While there are certainly advantages to having the seller pay points on behalf of the buyer, there are also some potential drawbacks. For instance, the buyer may pay a higher price for the home if the seller uses the points as a negotiating tool. Additionally, the buyer may not save any money on the loan if the points paid by the seller are not enough to offset the higher sale price of the home.
If you are a buyer considering a home where the seller offers to pay points, it is vital to do the math to determine if it is a good deal for you. Be sure to work with a lender and a real estate agent you trust to help you make an informed decision.
We’re here to help
When you’re buying a new home, it can already feel a bit overwhelming. When jargon such as “rate buy-down” or “points” enters the mix, we understand that it may seem too much to sort through on your own. The good news is the mortgage experts at Queensborough National Bank and Trust are just a call or click away! Get in touch with your local lender today to get started on your home-buying journey.