What’s Better: A Rate Buydown or Price Reduction?
Using seller concessions for a rate buydown can lead to lower payments than requesting a lower purchase price.
Home shoppers are benefiting as they gain leverage over sellers in many areas of the country. While it’s tempting to use this leverage for a price reduction, you may get more benefit by requesting seller concessions toward a rate buydown instead.
Rate Buydown vs Lower Home Price
So, how does a rate buydown compare to making an offer at a lower purchase price? In short, funds toward buying down the rate typically result in lower payments than requesting a price reduction.
| Loan Attribute | Buydown | Price Reduction |
|---|---|---|
| Original Home Price | $300,000 | $300,000 |
| Seller Funds | $5,700 | $5,700 |
| New Home Price | $300,000 | $294,300 |
| Loan Amount (5% Down) | $285,000 | $279,585 |
| Rate | 6.5% | 7% |
| P&I Payment | $1,801 | $1,860 |
In this example, using seller funds for a rate buydown costs the homebuyer $59 less each month than if they were to request a price reduction.
How Much Does the Home Price Need to Drop to Equal a Rate Buydown?
You’ll generally need a massive price reduction to match the payment and interest savings of a rate buydown.
Here's an idea of the equivalent home price reduction needed to equal a rate buydown of 0.25%, 0.50%, and 1% across a range of purchase amounts. All figures assume a 0.25% rate reduction for each discount point.
0.25% Rate Buydown vs Price Reduction For Same Monthly Payment
| Home Price | 0.25% Rate Buydown (Assumes Cost of 1%) | Price Reduction To Save the Same Amount Monthly |
|---|---|---|
| $250,000 | $2,375 | $6,439 |
| $300,000 | $2,850 | $7,726 |
| $350,000 | $3,325 | $9,014 |
| $400,000 | $3,800 | $10,302 |
| $500,000 | $4,750 | $12,877 |
| $750,000 | $7,125 | $19,316 |
| $1,000,000 | $9,500 | $25,755 |
0.50% Rate Buydown vs Price Reduction For Same Monthly Payment
| Home Price | 0.50% Rate Buydown (Assumes Cost of 2%) | Price Reduction To Save the Same Amount Monthly |
|---|---|---|
| $250,000 | $4,750 | $13,145 |
| $300,000 | $5,700 | $15,774 |
| $350,000 | $9,014 | $18,403 |
| $400,000 | $6,650 | $21,032 |
| $500,000 | $7,600 | $26,290 |
| $750,000 | $9,500 | $39,435 |
| $1,000,000 | $19,000 | $52,581 |
1% Rate Buydown vs Price Reduction For Same Monthly Payment
| Home Price | 1% Rate Buydown (Assumes Cost of 4%) | Price Reduction To Save the Same Amount Monthly |
|---|---|---|
| $250,000 | $9,500 | $24,708 |
| $300,000 | $11,400 | $29,649 |
| $350,000 | $13,300 | $34,591 |
| $400,000 | $15,200 | $39,532 |
| $500,000 | $19,000 | $49,415 |
| $750,000 | $28,500 | $74,123 |
| $1,000,000 | $38,000 | $98,830 |
*Calculations based on a 30-year fixed-rate loan with a 5% down payment. All figures are rounded to the closest dollar and are for example purposes only.
As the charts show, someone purchasing a $500,000 home could ask for $19,000 in seller concessions to potentially purchase four discount points, which has the same effect on the monthly payment as asking for a $49,415 price reduction.
How Does a Rate Buydown Affect Mortgage Payments?
Buying down your interest rate can result in lower monthly payments from day one. Borrowers planning to remain in their homes and keep their mortgages for the long term can use a rate buydown to generate substantial savings over the life of their loan.
For a $400,000, 30-year fixed-rate mortgage, dropping the rate by 0.5% (e.g., from 7% to 6.5%) saves about $133 per month, while a 1% drop (e.g., from 7.5% to 6.5%) saves roughly $269. These savings add up – over a year, that's $1,596 or $3,228, respectively, which can go toward other expenses or savings.
Many lenders allow you to purchase up to four discount points, equating to roughly a 1% interest rate reduction. Some mortgage companies, however, may have different limits.
Here’s a chart showing how much you could save on your monthly principal and interest (P&I) payments by using seller credits to purchase two discount points and reduce your interest rate from 7% to 6.5%.
| Home Price | P&I (7%) | P&I (6.5%) | Monthly Savings | Lifetime Savings |
|---|---|---|---|---|
| $250,000 | $1,580 | $1,501 | $79 | $28,416 |
| $300,000 | $1,896 | $1,801 | $95 | $34,098 |
| $350,000 | $2,212 | $2,102 | $110 | $39,782 |
| $400,000 | $2,528 | $2,402 | $126 | $45,464 |
| $500,000 | $3,160 | $3,002 | $158 | $56,831 |
| $750,000 | $4,740 | $4,503 | $237 | $85,247 |
| $1,000,000 | $6,320 | $6,005 | $315 | $113,662 |
*Calculations based on a 30-year fixed-rate loan with a 5% down payment. All figures are rounded to the closest dollar and are for example purposes only.
When Might a Lower Purchase Price Be Better?
Long-term homeowners are more likely to benefit from a rate buydown than from offering a lower purchase price. However, there are some situations where it may make more sense to go with the price reduction instead.
Scenarios where a lower purchase price may actually be better include when:
You only plan to live in the home for a few years before selling.
Interest rates are decreasing, and you expect to refinance in the next few years.
You’re working to improve your credit and can likely qualify for a lower rate once you pay off debts and raise your score.
You're making a massive down payment or paying for your home fully in cash.
You anticipate coming into a lump sum of money, such as an inheritance or settlement, or will otherwise be able to pay off your mortgage within the foreseeable future.
What Is a Rate Buydown?
A rate buydown is when funds are applied to lowering the mortgage interest rate. It’s a strategy homebuyers can use to reduce their monthly mortgage payments. The buydown involves purchasing lender discount points to lower the borrower's interest rate, reducing costs for the duration of their loan.
How Lender Discount Points Work
Lender discount points are effectively the prepayment of mortgage interest. Each “point” equals 1% of the loan amount. The resulting rate reduction varies, but is sometimes around 0.25%.
These mortgage points are paid for upfront and due as part of your closing costs.
For Example: You've qualified for a $400,000 loan at an interest rate of 7%. The lender informs you that paying two discount points costs $8,000, but your interest rate would decrease by 0.5% (figures are for example purposes only).
What Are Seller Concessions?
Seller concessions are funds a home seller agrees to credit to the buyer at closing. These contributions are negotiated as part of the sales agreement. They can be stated as a fixed dollar amount or percentage of the purchase price.
In most cases, buyers can only use concessions to cover closing costs, including buying discount points. However, borrowers with VA-backed loans have some added flexibility, which we'll touch on in just a bit.
Seller concessions typically include the phrase "up to," meaning that the seller is only responsible for covering the buyer's actual costs, even if the agreed-upon concessions are higher. As such, home shoppers need to ensure they're using seller concessions to their maximum value.
Using Seller Concessions for a Rate Buydown
One of the most effective ways to use seller concessions is to purchase lender discount points for a rate buydown. Not only does this strategy help to fully use concessions, but it can also lead to considerable monthly and long-term savings that can far exceed a comparable price reduction.
Seller Concession Limits by Loan Type
The amount you can receive in seller concessions varies depending on the type of mortgage you're applying for. We'll go over each loan type individually, but here's a basic overview for reference:
| Loan Type | Seller Concession Limit |
|---|---|
| Conventional | 3% to 9% |
| FHA | 6% |
| VA | 4% + standard closing costs |
| USDA | 6% |
Conventional Loans
Seller concession limits for conventional loans are unique in that the amount you can receive depends on the size of your down payment. With the 5% down we've used for our examples, conventional borrowers are limited to 3% in concessions.
However, if you’re putting a larger amount down, it’s possible to receive as much as 9% of your purchase price back as seller credits to put toward closing expenses and your rate buydown.
| Down Payment | Max Seller Concession |
|---|---|
| Less than 10% | 3% |
| 10% to 24.99% | 6% |
| 25% or more | 9% |
Keep in mind that these figures only apply to your primary residence or second/vacation home. For investment properties, conventional seller concessions are limited to 2%, regardless of your down payment.
FHA Loans
FHA loans – mortgages backed by the Federal Housing Administration – have a maximum seller concession limit of 6%. This limit is typically calculated based on your purchase price. However, if the home's appraised value comes in lower, the 6% applies to the lesser amount.
VA Loans
VA loans insured by the US Department of Veterans Affairs have some of the most flexible rules regarding seller concessions. While the VA program's limit is set at 4% of the sales price, that does not include credits issued to cover standard closing costs. This means a seller can pay for all the borrower's customary closing costs and provide an additional 4% concession toward a rate buydown.
Also unique to VA loans is that borrowers can use seller concessions for a few other purposes separate from buying down their rate or covering traditional closing costs. These uses can include:
Payment of the VA funding fee
Paying off existing debts and credit balances
Gifts of personal property such as televisions and home appliances
Note: In some areas, discount points are already figured into the interest rate that lenders quote buyers. VA guidelines explicitly state that these market-dictated points are considered customary closing costs and do not count toward the 4% contribution limit.
USDA Loans
USDA loans, secured by the US Department of Agriculture, are available with zero-down payment for properties located within designated rural communities. The seller contribution limit is 6% of the sales price for all USDA loans.
Tips for Negotiating a Rate Buydown
Since asking for seller concessions to pay for a rate buydown can have the same effect as a larger offer reduction, it should go without saying that sellers will be more inclined to agree to closing credits than a massive price cut.
Still, not everyone will be open to seller concessions, particularly homeowners with desirable properties or who are in no rush to sell. How can you increase your odds of getting a seller to for a rate buydown approved? Here are some tips:
Understand market conditions: You'll have far more luck finding sellers receptive to the idea of contributing to your closing costs when shopping in a buyers' market. Sellers can offer fewer incentives when most properties are put under contract at full value within days of being listed.
Consider hard-to-sell properties: Sellers with freshly listed or highly desirable homes are less likely to offer to pay for a rate buydown. Instead, consider looking at hard-to-sell properties such as those that have already spent a higher-than-average time on the market or that need a little more work than similar listings.
Keep your options open: You're in the best position to negotiate a rate buydown if you're willing to walk away. If a seller won't accept your request, keep shopping around for the right home until you find one who will.
Should You Do a Rate Buydown?
For most buyers, requesting seller credits to pay for a rate buydown will reduce monthly payments and long-term costs far more than a comparable price reduction. To understand how purchasing lender points can lower your interest rate and save you money, get a personalized estimate from an experienced local lender.
