Temporary Buydown on an Interest-Only Loan

A temporary buydown is a way that a borrower can negotiate lower interest rates for a period of time on his or her home loan. In reality, the borrower is paying the higher interest at the closing of the loan instead of over the first period of the loan. Temporary buydowns are good options for people that have access to excess cash at the time that they sign a loan and do not think that their cash flow in the upcoming months will be enough to cover the interest rates. Lenders can also pay the upfront cost of a temporary buydown in order to ensure and speed up the sale of a loan.   

Interest-Only Loans

Interest-only loans are loans that do not require the borrower to pay money towards the principal of a home loan for a period of time. This type of loan is good for people who think that they will have cash flow problems in the near future. The period of time that a borrower can avoid paying money towards a principal is limited.   

The Connection

If you use the option to take a temporary buydown on an interest-only loan, you will be maximizing your likelihood of making monthly payments. Not only will your payments be lower because you will not be paying towards your principal, but also the rate of interest that you will be paying will be lower because of the money that you pay upfront in the buydown.

The common types of temporary buydowns are called 3-2-1 and 2-1 options. If you secure a 3-2-1 buydown on an interest-only loan, during the first six months of your loan you will pay an interest rate every month that is three points lower than the original rate. During the next two months you will pay two points lower. During the next six months you will pay one point lower. After that time period you will pay the original interest rate. If you secure a 2-1 temporary buydown, you will see discounts for two six month periods and those discounts will begin two points below the regular interest rate.

The combination of a temporary buydown and an interest-only loan means that you will eventually face a large increase in monthly payments. Once the discount from your buydown expires, you will pay the regular interest rate. Once your interest-only period ends, you will need to pay a monthly amount of money towards your principal. If you plan on using a temporary buydown on an interest-only loan, be sure that your monthly income will be greatly increased in the future.