A reduction in the interest rate of a loan is referred to as a buy-down. A payment made when the loan is taken out, either by the borrower or the lender often compensates this reduction . This payment is known as buying discount points, when it is made by the buyer.

Discount point or Origination point

Discount point, which is also referred to as origination point or simply point, is the fee paid at the time of borrowing. One discount point is equivalent to one percentage of the loan amount. If in case it is a permanent buy-down then buying one point can lower one’s interest rate by about 0.125% over the term of the loan.

Buy-downs are mostly temporary

However, most buy-downs are temporary. Only for the first few years the reduction in rate is applicable. A reduction in interest rate for the first two years of the loan is referred to as 2/1 buy-down. When the reduced rate is applicable for almost three years, then it is referred to as a 3/2/1 buy-down.

Reasons why to choose the buy-down option

There are numerous reasons due to which people may choose the buy-down option. One is the financial hardship. When a buy-down is in effect loan payments gradually increase. Another reason is that there could be a need to expand the loan for which a borrower could qualify, since the initial monthly payments would be lower. Of course, this is entirely dependent on whether the lender factors in the buy-down ratio when determining the size of the loan.

Possibility of Tax Reductions

Due to buy-down tax reductions are also possible.

A borrower can obtain a tax deduction for that year by paying the discount points for a buy-down in the year of the loan closing. The lower interest rate in subsequent years results in lower monthly payments, while reducing tax benefits.

Beneficial for both borrowers as well as Lenders

Buy-downs not only shows their benefits for borrowers, but they are also beneficial for lenders as well. Buy-downs are offered either temporarily or permanently in the construction industry, having a reduced interest rate throughout the duration of the loan, so that they may encourage people to buy more property. In such cases, the discount points are paid by the lender.

Use of buy downs for mortgage loans

Often buy-down is  used for mortgage loans. A borrower should calculate when her savings from the reduced rate would be equivalent to the payment made for the discount points when considering whether to obtain a permanent buy-down.  It is entirely dependent on the one who is buying the discount points that whether the buy downs are beneficial or not.

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