Temporary vs. Permanent Mortgage Buydowns: Which to Choose and Why

Mortgage rates are not that low these days. In fact, they’ve basically doubled since early 2022.

While this is clearly not good news for aspiring home buyers or those looking to refinance, it has opened the doors for some creative solutions.

Recently, temporary purchases have taken center stage after being a very niche product.

And many home buyers are opting to pay off discount points at closing to lower their rates.

The question is, do you want to lower your rate permanently, or do so only temporarily?

Temporary vs Permanent Mortgage Purchase

First, you need to know the difference between temporary purchases and permanent purchases.

Permanent Purchase (payment point at closing for a reduced rate for the term of the loan)

Permanent buydown involves paying discount points to lower your mortgage rate for the life of the loan.

For example, let’s say you have a loan amount of $500,000 and you’re offered a 6.5% rate on a 30-year fixed mortgage with no points.

This would result in a monthly principal and interest payment of $3,160.34.

You are not very impressed as you have seen ad rates in the range of 5% and hence you inquire about the same.

The loan officer or broker states that you can get a rate of 5.75% if you are willing to pay two discount points at closing.

You’ll pay $10,000 to lower the mortgage rate, but you’ll have that rate locked in for all 30 years.

The payment would drop to $2,917.86, representing a savings of approximately $250 per month. not bad. But you still need to recover your $10,000!

Temporary purchase (getting a lower mortgage rate for only 1-2 years)

Then there is the temporary purchase, which as the name implies Temporary, This means that your mortgage rate will only be lower for a short period of time.

In most cases, we are talking about the first year or two of your loan, which would be a loan term of 30 years.

So for 28 to 30 years, temporary buying won’t do you any good. And perhaps worse, the mortgage rate will go back to what it should have been without the purchase.

For example, if you elected to use the 2-1 buydown, it would temporarily reduce your interest rate to 2% in the first year and 1% in the second year.

If the note rate was 6.5%, you would enjoy a rate of 4.5% in the first year and 5.5% in the second year. But after that the savings will be gone.

Then you’ll be on the hook for the full 6.5% mortgage rate, which can create some payment shock.

By shock, I mean paying more than what you used to. After all, it’s easy to get used to a low monthly payment, then feel blindsided when it increases.

As a real-world example, imagine the loan amount was $500,000. The payout will increase from $2,533.43 to $2,838.95 and finally to $3,160.34.

The saving grace is that it is somewhat gradual as the rate is reduced by 2% in year one, but just 1% in the second year.

Thus the jump in payments is not that drastic. Still, this is a very temporary solution to lower payments.

The decision may hinge on where rates go next (and where you might go!).

Now that we know how each type of purchase works, we can discuss which may be better suited for certain situations.

Most proponents of temporary purchases point to the high mortgage rates currently being offered.

To that end, they see it as a bridge to lower mortgage rates in the near future, when interest rates go back down.

They argue that you’ll only need it for a year or two before rates drop and you have the opportunity to apply for rate and term refinancing.

Additionally, you only pay for what you’ll actually use (temporary buydown funds are kept in a buydown account and are usually returned if you sell/refit before expiration).

On the other hand, sustainable buying can result in paying for something you don’t actually use.

For example, imagine if you pay two points ($10,000 in our example) at closing, and then unexpectedly decline.

Suddenly you’re in the money to refinance, but you’re hesitating because you paid those non-refundable points upfront.

If rates drop enough, say to 5%, you’ll need to go for a refinance to eat up that cost and save even more.

If mortgage rates don’t drop dramatically, you could still lose if you sell your property before breaking even on the upfront cost.

At that point, even a bought-down rate won’t do you any good. That’s why you really need to think about your expected tenure in the home (and the loan) before paying points for a permanent purchase.

Can You Finance Mortgage Points?

for the record, there is Too Financed permanent buydown mortgage, which allows you to roll the points into the loan amount.

In our example, instead of a loan amount of $500,000, you would receive a loan amount of $510,000. But a lower interest rate would still equate to a cheaper payment.

It can also increase your purchasing power at the same time, allowing you to buy more homes.

While the financing aspect can reduce your cash burden at closing, it still leaves you in a pickle if you refinance or sell soon.

You are stuck with a larger loan amount if you refinance or less income if you sell. Also not entirely ideal if you don’t hold the home/loan for long.

Which is the better option?

Overall, make sure you understand the difference between a temporary and a permanent purchase to ensure you’re not paying extra for something you can’t use.

Or perhaps buying a home you may not be able to afford at the real interest rate!

For those who plan to stay in their home for a while, a permanent purchase may make more sense.

But this assumes that mortgage rates don’t drop dramatically. Because if they do, the card will likely get refinanced.

Conversely, if you expect to sell or refinance soon, a tentative purchase may be more favorable.

If you don’t think you’ll reach the break-even period, it reduces your chances of leaving money on the table.

Of course, if rates don’t fall, or even rise (and you don’t sell), you may wish to buy perpetually.