What is ‘Buy-Up’
A buy-up is a rebate system where the lender pays a borrower or a mortgage broker for a higher interest rate home loan. When the borrower receives the buy-up rebate, it must be used to defray loan settlement costs. The rebate cannot apply to the down payment, although as a practical matter the reduction of settlement costs leaves the borrower with more money toward a down payment. When the rebate goes to a third-party mortgage broker, it is known as a yield spread premium (YSP) and is part of the broker’s compensation.
Buy-ups are also known as negative points because they are the opposite of conventional or positive points.
BREAKING DOWN ‘Buy-Up’
The calculation of buy-ups is according to percentage points on the total loan value. Just as a buyer may purchase points to lower their interest rate, they may rebate points to raise the interest rate. For example, on a $100,000 loan with 4.5% interest, if the buyer wants 2.5 points of the rebate, they will receive $2500.
In a typical buy-up, each negative point buys one-quarter of a percentage point (.25) of interest. So in the above example, if the market interest rate were 4.5 percent, the 2.5-point buy-up would increase the interest rate by .625 percent, resulting in an actual mortgage of 5.125 percent. Buy-ups usually cannot be higher than the settlement costs and are not extra cash to pocket for the buyer.
When Buy-Ups Make Sense
If the borrower expects to hold the mortgage for a short period, receiving a rebate in exchange for a higher interest rate can be economically advantageous. That’s because the reduction in out-of-pocket loan settlement costs can offset the increased interest which will be paid out over a short time horizon. Again, using the example above, the original mortgage rate of 4.5 percent yields a monthly payment of about $507. With the 2.5-point buy-up, that monthly rate jumps more than 7 percent, to $544. To come out ahead, the buyer would need to sell the house or refinance within the first six years. Thus for buyers of starter homes or those who expect to sell the home within a few years, the savings in settlement costs can be worth it.
Where buy-ups become complicated is when they are paid to mortgage brokers, or even rebated to lenders themselves, as part of their commission. Before 2010 those yield spread premiums (YSP) were often obscured in the loan terms, making it hard for consumers to know when they were paying negative points to a broker or lender. Changes in federal guidelines for the loan estimate now require that a third-party broker’s yield spread premium be disclosed. Loan estimates were previously known as the good faith estimate (GFE).
However, premiums paid within the lending institution to its officers are not always clearly spelled out. The consumer could be paying a buy-up without knowing it. Buyers should ask questions and be clear in advance on what, if any, negative or positive points are being paid in a loan.