How Does a Temporary Mortgage Rate Buydown Work in California?

Have you heard about the temporary mortgage rate buydown but aren’t sure how it works? Wondering if it’s the right financing strategy for you? You’ve come to the right place!

In this article, you’ll learn how a temporary mortgage rate buydown works in California, and how it might benefit you as a home buyer.

What Is a Temporary Mortgage Rate Buydown?

A temporary mortgage rate buydown is a program that allows California home buyers to reduce their monthly mortgage payments for a limited period of time by paying a lump sum of money at closing. The money is then used to lower the borrower’s interest rate for a specified number of years, usually one to three years.

For example, let’s say a borrower gets a 30-year fixed mortgage with a 6% interest rate and a $5,000 temporary buydown. The buydown would lower the borrower’s interest rate to 5% for the first year, 5.5% for the second year, and 6% for the third year. This would result in lower monthly payments for the first three years of the loan.

The money for a temporary mortgage rate buydown can be provided by the seller, the lender, or the borrower. If the seller pays for the buydown, it is considered a “seller concession.” This means that the seller is essentially giving the buyer money to help them afford the home.

Temporary mortgage rate buydowns can be a good option for borrowers who want to lower their monthly payments in the short term. However, it is important to remember that the borrower will still be responsible for paying the full interest rate on the loan after the buydown period ends.

How Buydowns Differ from Traditional Mortgages

Temporary rate buydowns differ from traditional mortgages primarily in the early payment structure. In a traditional fixed mortgage, the interest rate remains constant throughout the loan term, resulting in consistent monthly payments

In contrast, a buydown introduces a variable interest rate structure during the initial years of the mortgage, which gradually increases over time.

This variation allows home buyers in California to take advantage of lower interest rates early on, providing a kind of financial relief during the first years of homeownership. As the mortgage progresses, the interest rates may adjust according to the terms agreed upon.

Potential Benefits for Home Buyers

We’ve touched on some of the benefits home buyers can enjoy when using a temporary mortgage rate buydown to buy a home in California. Now let’s take a closer look at those and other benefits.

Lower Initial Monthly Payments

One of the most significant advantages of a temporary rate buydown is the lower initial monthly payments. This can be especially helpful for first-time home buyers in California who might be adjusting to new financial responsibilities. With reduced payments during the initial period, homeowners can allocate funds towards other essential expenses or financial goals.

Affordability During the Early Years

Temporary buydowns can make homeownership in California more affordable, especially during the critical early years when moving and furnishing can strain the borrower’s budget. By having lower mortgage payments, individuals and families have a smoother transition and more room to breathe financially.

Flexibility in Financial Planning

A buydown could also give a homeowner additional flexibility when it comes to financial planning. For instance, homeowners could leverage the reduced payments to save, invest, or pay down other debts. This flexibility can be particularly beneficial for those anticipating changes in income, career, or family size in the near future.

How the Process Works: Example Scenario

In California, temporary mortgage rate buydowns are usually based on a formula that gradually adjusts the interest rate over the initial years of the mortgage. This formula, often referred to as the “Three-Two-One” or “3-2-1” rate buydown, creates specific reductions in the interest rate for each of the first three years of the loan term.

First Year: 3% Below Note Rate

In the initial year of the mortgage, the interest rate is set at 3% below the note rate. For instance, if the note rate is 4.5%, the first-year rate would be 1.5%. This reduction leads to significantly lower monthly payments compared to a traditional mortgage, offering immediate financial relief.

Second Year: 2% Below Note Rate

In the second year, the interest rate adjusts to 2% below the note rate. Using the previous example, if the note rate is 4.5%, the second-year rate would be 2.5%. While the reduction is slightly less than the first year, it still contributes to continued affordability.

Third Year: 1% Below Note Rate

During the third year, the interest rate would be 1% below the note rate. So, in our ongoing example, the third-year rate would come to 3.5%. While it’s a smaller discount, it would still result in more affordable monthly payments for the borrower (compared to a regular mortgage without a temporary buydown).

When Does It Make Sense to Use a Buydown?

A temporary mortgage rate buydown might make sense for a California home buyer in the following situations:

• When interest rates are high. If interest rates are high, a temporary buydown can help to lower your monthly payments in the short term. This can make a home more affordable if you are on a tight budget.
• When you have limited down-payment funds. A temporary buydown can help you to qualify for a larger loan amount, even if you have a low down payment. This can make it possible for you to buy a more expensive home.
• When you expect your income to increase in the near future. If you expect your income to increase in the near future, a temporary buydown can help you to lower your monthly payments until your income increases. This can free up cash that you can use for other expenses, such as saving for retirement or investing.
• When you are buying a fixer-upper. If you are buying a fixer-upper, a temporary buydown can help you to lower your monthly payments while you are making renovations. This can make it easier to afford the cost of repairs and improvements.

Here are some additional considerations when deciding whether or not to use a temporary mortgage rate buydown:

• Your budget: Can you afford the upfront cost of the buydown?
• Your income: Do you expect your income to increase in the near future?
• Your plans for the home: Are you planning to stay in the home for the long term?
• The interest rate: What is the current interest rate? Is it likely to go down in the near future?
• The buydown terms: How long is the buydown period? How much will it cost?

Have mortgage questions? Bridgepoint Funding has been helping California home buyers and homeowners with their mortgage needs for nearly 20 years. We offer a broad range of loan options and can help you choose the right product for your particular situation!