A mortgage buydown program results in a lower interest rate and lower monthly payment for the first few years of a new home loan. The Federal Housing Administration allows lenders to offer a 2/1 buydown, where the rate on a 15- or 30-year mortgage is reduced by 2 percent in the first year and 1 percent in the second year. There is a cost involved. The money to pay for the buydown goes into an escrow account to cover the difference between the lower payments for the first two years and the payments for subsequent years through the remaining loan term.
Calculate the loan payments based on the initial loan amount for the real rate of the mortgage and as if the interest rate was 1 and 2 percent lower. An online calculator or spreadsheet-based loan calculator will speed up the process. For example, a $150,000, 30-year mortgage at 6 percent would have a monthly payment of $899.33. With a 2/1 buydown, the rate would be 4 percent for the first year and 5 percent for the second year, with monthly payments of $716.12 and $805.23 , respectively.
Subtract the two lower monthly payment amounts from the regular monthly mortgage payment calculated at the full rate and multiply each difference times 12. In this example, at 4 percent, the difference is $183.21, producing a total payment reduction of $2,198.52 over 12 payments. At 5 percent, the monthly payment is $94.10 lower than the 6 percent payment and multiplying that by 12 equals $1,129.20.
Add the payment differences for the two years of the 2/1 buydown. In this example, $2,198.52 plus $1,129.20 equals $3,327.72. This total is the actual cost in lower payments to have a 2/1 buydown on a $150,000 mortgage with a 6 percent rate.
The lender may charge more or less than your calculated cost of an FHA buydown. If the final rate of the loan is higher than what you would pay on an FHA loan without a buydown, the cost could be less due to negative discount points on the loan rate.
If the loan officer wants to charge more for the buydown, the lender is adding some profit into the buydown. If the seller or another party is paying the buydown, it has little effect on your rate and payments.
- Mortgage Professor: What is a Temporary Buydown
- Michigan.gov: Single Family FHA Loan Program
- Bigger Pockets: Interest Rate Buydown Programs For FHA and VA Loans
- Board of Governors of the Federal Reserve System. "Consumer Handbook on Adjustable-Rate Mortgages." Page A1. Accessed April 3, 2020.
- FHA Government Loans. "FHA Loans—A to Z Index." Accessed April 3, 2020.
- Federal Trade Commission Consumer Information. "Shopping for a Mortgage." Accessed April 3, 2020.
- National Foundation for Debt Management. "Glossary of Mortgage Terms." Accessed April 3, 2020.
- Washington State Housing Finance Commission. "Home Advantage Program." Accessed April 3, 2020.
- The lender may charge more or less than your calculated cost of an FHA buydown. If the final rate of the loan is higher than what you would pay on an FHA loan without a buydown, the cost could be less due to negative discount points on the loan rate.
- If the loan officer wants to charge more for the buydown, the lender is adding some profit into the buydown. If the seller or another party is paying the buydown, it has little effect on your rate and payments.
Tim Plaehn has been writing financial, investment and trading articles and blogs since 2007. His work has appeared online at Seeking Alpha, Marketwatch.com and various other websites. Plaehn has a bachelor's degree in mathematics from the U.S. Air Force Academy.