A buy-down feature of a loan is not the same as “buying down” the rate. Though similar sounding, they are entirely different. Buying down the rate refers to the common practice of paying discount points to obtain a rate lower rate than the listed rate. A “buy-down” is a temporary reduction in rate for a specified time. A 2/1 buy-down means the rate for the first year of the mortgage will be 2% less than the actual note rate, and the rate for the second year will be 1% less than the note rate. In the third year and subsequent years the borrower will pay the actual note rate. For example, a borrower with an 8% fixed rate loan with a 2/1 buy-down will have an interest rate of 6% the first year, 7% the second year, and 8% for all years thereafter. There are numerous combinations for buy-down options, but the most common are the 2/1 and the 3/2/1.

A buy-down is not a free lunch. The additional points paid at closing for the buy-down roughly offset the reduced payments made during the buy-down period. So why use a buy-down? There are a number of situations where a buy-down makes sense. This list is not complete, but it provides some insight into the possibilities made available with buy-downs.

• A buy-down makes the payments lower initially. If the borrowers are expecting an increase in their income, a buy-down is a method of making the payments affordable with the lower income, and deferring the higher payments until the income has increased. For this option to work, the seller (or builder) would pay the discount points required for the buy-down. Hence, instead of negotiating strictly on price, the buyers would also negotiate for buy-down points.
   

• If borrowers need to extend their level of qualification (need to stretch the amount of loan they qualify for), a buy-down may be the answer. Although closing costs increase (unless the seller is paying the buy-down points), the lower initial monthly payment may increase the amount of qualification. The various loan products treat buy-downs differently, and some don’t allow the use of a buy-down in the qualification ratios. Check with your Loan Officer about specific details on a loan that interests you.
   

• In some cases the borrowers have a relocation plan that pays a specified number of discount points. Depending on the circumstances of the borrower, it may be more beneficial to apply the discount points to a buy-down instead of a lower note rate. A Loan Officer can assist with this analysis.
   

• Some borrowers use a temporary buy-down as a means of accelerating tax benefits. In order to move tax deductions into the year of closing, discount points are paid for the buy-down. The interest deduction (on the discount points) is immediately beneficial. Although the tax benefits are slightly reduced during the subsequent buy-down period, the payments are also lower. Check with your tax advisor on the feasibility of using this strategy.

A buy-down may make sense for you. Discuss your objectives with a Loan Officer for the best combination of loan program, fixed or adjustable rate, and buy-down possibilities.