3 Ways to Reduce Your Interest Rate When Buying a Home

Are you kicking yourself for not buying when mortgage rates were lower? You’re not alone! With the housing market slowing, sellers reducing prices and interest rates peaking at the highest level in 20 years, many would-be buyers have put their plans on pause. 

But is waiting really the smartest strategy? 

While we try not to give blanket advice, our team is still generally encouraging clients to pursue homebuying because it supports long-term wealth building. After all, 7% is 93% less than 100% interest (which is what you pay when you continue to rent). 

“There is no doubt that these higher rates hurt housing affordability. Nevertheless, apart from borrowing costs, rents additionally rose at their highest pace in nearly four decades.” - Nadia Evangelou, Senior Economist and Director of Forecasting at the National Association of Realtors (NAR)

If you’re thinking about buying in the new year, it’s important to understand there are a number of creative loan programs that can temporarily reduce your interest rate. 

2-1 Buydowns

With a 2-1 buydown mortgage, the buyer pays a lower interest rate over the first two years of the loan in return for an up-front payment of the interest. The interest rate is reduced by 2% in the first year, 1% in the second year, and then the full interest rate for the remainder of the mortgage. This is the most common buydown option.

For example, if rates today are at 7%, the first year’s rate would be at 5%, the second year’s rate would be at 6% and then the remainder of the loan would go back to 7%.

Costs on this are typically around 2-3% of the purchase price and can be used on FHA, VA and Conventional Loans regardless of down payment size.

3-2-1 Buydowns

With a 3-2-1 buydown mortgage, the buyer pays a lower interest rate over the first three years in return for an up-front payment of the interest. The interest rate is reduced by 3% in the first year, 2% in the second year, and 1% in the third year. 

For example, if rates today are at 7%, the first year’s rate would be at 4%, the second year’s rate would be at 5%, the third year’s rate would be 6% and then the remainder of the loan would go back to 7%.

Costs on this are typically around 4% of the purchase price, so on a conventional loan the borrower must have at least a 10% down payment since that allows for over 3% in seller concessions.

Who Can Buy Down A Mortgage?

Although it’s the buyer (or borrower) who benefits from a buydown, the buyer isn’t always the one who buys down a mortgage. Sellers and builders can also be responsible for purchasing points to lower the buyer’s interest rate.

Sellers may offer to buy down a buyer’s mortgage to incentivize the buyer to purchase their home. In these circumstances, the seller will make the one-time payment and deposit it into an escrow account or pay for points over the entire loan term as part of seller concessions.

Adjustable-Rate Mortgage (ARMs)

An adjustable-rate mortgage is a home loan with an interest rate that adjusts over time based on the market. The fixed period on these can be 5, 7 or 10 years, so it’s a great option for buyers who want to take advantage of a lower rate but want the security of a longer fixed period than the buydown options offer. 

For example, let’s say you take out a 30-year ARM with a 5-year fixed period. That would mean a low, fixed rate for the first 5 years of the loan. After that, your rate could go up or down for the remaining 25 years of the loan.

The Bottom Line: Should You Buy a Home Now or Wait? 

If you’ve found a home that you can afford and it meets your family’s needs for the next five years, it’s reasonable to move forward with the purchase. This may sound like a very simple answer, but we find it difficult to perfectly time the housing market. By taking advantage of one of these creative loan options, you can get into your dream home now at a lower rate and refinance once rates drop in the future.

Traditionally, markets like this will stabilize, but when that happens is up in the air. If you’re thinking about buying a home in the new year, reach out to our team! We’re here to help you decide if it makes sense to make a move now or wait!