Question:

What are permanent buy down mortgages and temporary buy down mortgages and which are better?

Answer:

A permanent buy down mortgage is one where the buyer of the house makes more than the required upfront payment in order to reduce the interest on the loan for the entire lifetime.

In a temporary buy down mortgage, the same thing happens with the only difference being that the reduction in interest rate is not for the whole period of the loan. Rather the reduction is only for the first few (typically 3-5) years of the loan.

Example of a Permanent Buy Down:

Consider a $100,000 6% 30-year loan. Suppose the borrower has $2000 on hand which he wants to use to ‘buy down' the interest rate of the mortgage. By paying the $2000 upfront his monthly payments would reduce from $600 to $588 for all 30 years of the loan.

So in effect the interest rate of the mortgage would be reduced from 6% to 5.81% by paying $2000 upfront.

Example of a Temporary Buy Down:

Consider a $100,000 6% 30-year loan. Suppose the payment rate is 1% less than the interest rate (i.e. 5%) for only the first year. In that case the monthly payment would reduce from $600 to $537 for the first year only.

The difference over the year would be $63 x 12 = $756 and that is the amount the lender will need compensation for.

Permanent Buy Down Mortgage Vs. Temporary Buy Down Mortgage

While it is true that temporary buy down mortgages are more popular than permanent buy down mortgages, it really depends on every individual case which type suits it.

If you are looking for a long term commitment to a home then a permanent buy down can be beneficial to you.

However, most people do not want to make such long term commitments and may want to have the option of refinancing open. For them obviously the temporary buy down option is the right one. An important statistic is that the average period a family stays in a home is seven years.

Working of Buy Down Mortgages

In both types of buy down mortgages the buyer of the house may bear the cost either directly or indirectly. In a direct transaction the buyer pays the extra amount (also called discount points) up front and obtains a lower interest rate. In the indirect case, the builder or seller of the house makes payments to the mortgage lending institution and recoups the cost by increasing the price of the house.

There are several mortgage financing options available apart from buy down mortgages. It would depend greatly on the market conditions which type of mortgage would be suitable. Make sure you consult a professional before taking this very important decision of your life.

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