What is 'Buy-Up'
A buy-up is a rebate paid by a lender to a borrower or mortgage broker for a home loan, in return for a higher interest rate. When the rebate is paid to the borrower it must be used to defray loan settlement costs; it can’t be applied 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 is paid to a third-party mortgage broker it is known as a yield spread premium (YSP) and is part of the broker's compensation.
BREAKING DOWN 'Buy-Up'
Buy-ups are calculated according to percentage points of the loan value. For example, a rebate of $2500 on a $100,000 loan would be 2.5 points. Buy-ups are also known as “negative points” because they are the opposite of conventional or “positive points,” in which the borrower pays extra cash upfront to the bank, in return for a lower interest rate.
In a typical buy-up, each negative point “buys” .25 percent 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 can’t be greater than the settlement costs; there is no extra cash to pocket.
When Buy-Ups Make Sense
Receiving a rebate in exchange for a higher interest rate can be economically advantageous to a borrower—if the borrower expects to hold the mortgage for a short period of time. That’s because the reduction in out-of-pocket loan settlement costs can offset the increased interest that 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 a job transfer or other reason to move within a few years, the savings in settlement costs can be worth it.
Where buy-ups get 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 were often obfuscated 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 (previously known as the good faith estimate) now require that a third-party broker’s yield spread premium be disclosed.
However, premiums paid within the lending institution to its own officers are not always clearly spelled out, meaning a 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.