Refinance guide rate buydowns on refinance temporary vs permanent

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Rate Buydowns on Refinance: Temporary vs. Permanent

When refinancing a mortgage, homeowners may be offered a rate buydown as a way to reduce the interest rate and monthly payment. Buydowns can be temporary (short-term) or permanent (long-term). Understanding how each works, when each makes sense, and the costs involved will help you decide if a buydown is right for your situation.

What a rate buydown is — and when it makes sense

A rate buydown is a prepaid interest arrangement that lowers the mortgage interest rate for some or all of the loan term. Two common types:

  • Temporary buydown: The rate is reduced for an initial period (often 1–3 years) and then returns to the full note rate. Examples include 2-1 and 3-2-1 buydowns, which reduce the rate by 2% in year one, 1% in year two, then revert to the contract rate in year three, or a 1-year buydown that reduces the rate for just the first 12 months.
  • Permanent buydown (buying points): You pay mortgage points at closing (each point = 1% of loan amount) to lower the rate for the entire loan term. This is sometimes called “buying down the rate” or purchasing discount points.

When it makes sense:

  • Temporary buydowns: ideal if you need short-term payment relief (e.g., during a gap in income, after taking time off work, or while waiting for a bonus or promotion) or if you plan to sell or refinance within a few years.
  • Permanent buydowns: make sense if you plan to hold the loan long-term and the break-even period (time to recoup the cost of points through monthly savings) is shorter than the time you expect to keep the loan.

Benefits and drawbacks

Temporary buydowns — benefits:

  • Lower initial payments help with cash flow during transitional periods.
  • Sellers or builders may pay for the buydown to make the sale more attractive.
  • No long-term commitment to higher borrowing costs if you refinance or sell.

Temporary buydowns — drawbacks:

  • Monthly payments increase when the buydown expires.
  • Underwriting must support the full payment amount once the buydown period ends; you still need qualifying income for the higher payment.
  • Often funded by a lump sum paid into an escrow account; not always the most cost-effective way to buy down rates for long-term savings.

Permanent buydowns — benefits:

  • Lower interest rate and monthly payment for the entire loan life.
  • Predictable savings; can be worthwhile if you’ll keep the loan past the break-even point.

Permanent buydowns — drawbacks:

  • Upfront cost (points) can be substantial.
  • Break-even may be many years out, so not worthwhile if you plan to sell or refinance soon.
  • Points are generally nonrefundable if you refinance or prepay the loan early.

Costs and fees

Key costs to consider:

  • Discount points: Typically 0.25%–0.5% reduction in rate per point, but the exact reduction varies by lender and market conditions. Each point costs 1% of loan principal.
  • Buydown funding: For temporary buydowns, a lump-sum payment equal to the present value of the reduced payments is deposited into an account that supplements the borrower’s monthly payment during the buydown period. This can be paid by the borrower, seller, or builder.
  • Standard refinance closing costs: appraisal, title, escrow, underwriting, recording fees, and possible loan origination fees. Buydown points are additive to these costs.
  • Mortgage insurance and taxes: If mortgage insurance (MI) applies, your monthly MI may not decline proportionally; property taxes and insurance escrow must still be paid.
  • Tax implications: Discount points paid on a refinance are generally deductible over the life of the loan (amortized), not all at once, unless you meet specific IRS criteria. Consult a tax advisor for your situation.

Step-by-step process to evaluate and execute a buydown on refinance

  • 1. Gather loan offers: Compare quotes including the contract interest rate, APR, and how many points are required to achieve each rate.
  • 2. Calculate break-even: Divide the upfront cost of points by the monthly savings to find months to recoup the cost. If you’ll keep the loan longer than that, permanent buydown may be worthwhile.
  • 3. Consider temporary alternatives: If you need just short-term relief, evaluate 2-1 or 1-year buydowns and compare the cost to simply keeping savings in reserve or getting a slightly higher cash-out buffer.
  • 4. Negotiate who pays: On a refinance, buyer-seller credits don’t apply, but you can negotiate rate/points with the lender or use retained savings to fund the buydown.
  • 5. Confirm underwriting rules: Ensure lender allows the buydown structure; temporary buydowns must be properly documented and often require verification of funds used to fund the buydown account.
  • 6. Close and verify: At closing, confirm points and buydown funds are correctly reflected on the HUD-1/Closing Disclosure. After closing, verify the servicer applies the buydown payments correctly each month.

Common pitfalls to avoid

  • Not verifying break-even timing — paying points that won’t pay back before you sell or refinance.
  • Failing to account for the full higher payment after a temporary buydown ends — you must qualify for the full payment long-term.
  • Assuming a fixed rate reduction per point — reductions vary by lender and market; always confirm exact numbers.
  • Ignoring interaction with mortgage insurance — MI may remain the same and reduce the effective savings from a buydown.
  • Accepting seller-funded buydowns without checking local or loan program restrictions — some programs limit seller contributions or require specific disclosures.

Short FAQ

Q: How much does one point lower my mortgage rate?
A: Typically one point (1% of loan) reduces the rate by roughly 0.25% to 0.5%, but the exact reduction depends on the lender and market. Get lender-specific quotes for precise figures.

Q: Can a seller pay for a buydown on a refinance?
A: On a refinance, seller contributions aren’t applicable because there is no seller in the refinance transaction. For purchases, sellers or builders can pay for buydowns subject to program limits. For refinances, the borrower or a third-party (in limited cases) funds the buydown.

Q: Are buydown points tax-deductible?
A: For refinances, discount points are usually deductible over the life of the loan (amortized). If the refinance meets IRS rules and the points are used to improve your primary residence, special rules may apply. Consult a tax professional for your situation.

Q: Which is better — temporary or permanent buydown?
A: It depends on your goals. Choose temporary for short-term cash flow relief or if you plan to sell/refinance soon; choose permanent if you’ll keep the loan long enough to recoup the cost and want long-term savings.

Rate buydowns can be a useful tool during a refinance, but they require careful cost-benefit analysis. Run the numbers, confirm lender terms, and factor in how long you plan to keep the loan before deciding.

META: rate buydown refinance temporary permanent buydowns discount points break-even analysis FAQs

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