Interest Rate Buydowns – Reducing Borrowing Costs Upfront

A buydown involves paying an upfront fee (typically discount points) to reduce the loan’s interest rate.

Example:

We are purchasing a 70,000 square foot office building for $28,000,000.  The acquisition is being financed with a 7.25% fixed rate, interest-only loan of $15,400,000 (55% LTV) on a 7-year term.  The lender offers a 50 bps buydown to a 6.75% rate in exchange for a 1.5% upfront fee ($231,000).  The difference in debt service is $6,417 per month, or $77,000 annually.  The breakeven point would be 3 years where the borrower’s upfront buydown fee is offset, after which the borrower is ahead. 

Although the borrower can lower their monthly payments, the upfront buydown fee can be expensive.  And considering the other costs that might be incurred during the loan process, the required cash to close may not align with the investor’s goals.

What are some scenarios where it might make sense?  When the hold period is long enough to justify the upfront cost.  Also, it may be used to improve the debt-service-coverage ratio (DSCR), so the loan meets the lender’s criteria.  Some investors may also need stronger cash flow early on, which can be done through temporary buydowns where the rate is subsidized for the first couple initial years.