Discounted Rates and ARMs

The underlying concept of adjustable rate mortgages (ARMs) is, to some extent, the ability to get a lower introductory rate that is guaranteed for a specific amount of time, with the understanding that the lender may be able to adjust your rate upward later. However, this underlying bargain is not generally referred to as a discount. Instead, discount rates, also known as buydowns, refer to a completely different arrangement.

A buydown occurs when you, the consumer, pay an upfront fee in exchange for an initial rate that is lower than the sum of the index and margin. Just like the initial rate for a regular ARM, the discounted buydown rate is not permanent, but instead will expire at a pre-determined date.

You should be wary of these discounted rates for more than one reason. First of all, while a buydown may result in low rates, and therefore enticingly low monthly payments, at the beginning, you may be hit with a “double whammy” at some point. If your buydown expires and your rate is adjusted upward at around the same time, your payment may rise to a level you are uncomfortable with or cannot easily afford. Even if you think you will have the money to cover it, a sharp increase still has the potential to strain your finances.

Also, sellers may add the cost of the buydown to the total price of the house. The extra cost could offset any savings from the buydown. In fact, discounted rates in this situation can possibly end up costing more over time. Make sure you consider these facts before agreeing to a buydown in conjunction with an ARM. It may seem like a great deal at first, but the long-term consequences could be more than you bargain for.