Buying down your mortgage rate: It's not just one way or the other

For years after the Great Recession, mortgage interest rates hovered at historically low levels, and home buyers became accustomed to borrowing at less than 4 percent - and sometimes less than 3 percent. But in spring 2022, rates began to rise, and once they hit 6 or even 7 percent, buyers stepped up the search for ways to reduce them.

"Buy-downs," which reduce mortgage interest in exchange for upfront fees, quickly became popular for buyers, especially when sellers were willing to pay the upfront fees as an incentive to buyers in a slower market.

We asked Isabel Barrow, a certified financial planner with Edelman Financial Engines in Alexandria, Va., and Dan Hanson, executive director in market retail at loanDepot in Corona del Mar, Calif., for their insights into how a mortgage buy-down works and when it might be a good option. Text has been edited for clarity and space.

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Q: What is a buy-down?

Hanson: Rate buy-downs allow home buyers to reduce the interest rates on a mortgage by paying points upfront. There are two types - temporary and permanent. Temporary buy-downs offer you lower interest rates for an annual predetermined period such as one, two or three years. A permanent buy-down reduces your interest rate for the full term of the loan.

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Q: How does a temporary buy-down work?

Hanson: A "3-2-1" buy-down for a $400,000 mortgage at 6 percent costs approximately $18,000. Your first-year rate would be 3 percent [or down three points], second year 4 percent [down two points], third year 5 percent [down one point], and the fourth year through the remainder of your mortgage would return to 6 percent. You would save $732 per month the first year, $502 monthly the second year and $257 per month the third year.

Temporary buy-downs can be paid by the buyer,...