Real Estate

Basics of Today's Popular Mortgage Buydowns

Popular mortgage buydowns work like this.

• Payments are reduced and figured on a lower interest rate over a specific term.
• The difference between the "real" note rate and the lowered interest rate is paid in cash by the seller or the buyer.
• Think of it like a subsidy. It's like socking away $1200 in the bank and withdrawing $100 every month for 12 months to help make your mortgage payment.

The 3-2-1 Mortgage Buydown

• This is a 30-year fully amortized mortgage.
• The interest rate increases 1% every year for the first three years.
• Then the interest rate is fixed for the remaining term.

Here is an example. Say your loan balance is $350,000 and the interest rate is fixed at 6.75% for 30 years based on a 90% LTV of a selling price of $388,888. The seller (or you) could "buy down" the interest rate by paying a lump sum of $15,853. This is how it works:

 1. First-year interest rate is 3.75%, payable at $1,621 per month
 2. Second-year interest rate is 4.75%, payable $1,826 per month
 3. Third-year interest rate is 5.75%, payable $2,043 per month
 4. Years four through 30, interest rate is 6.75%, payable at $2,270 per month

• First-year savings (as compared to $2,270 per month) is $649 per month or $7,790.
• Second-year savings (as compared to $2,270 per month) is $444 per month or $6,332.
• Third-year savings (as compared to $2,270 per month) is $228 per month or $2,731.

Add up the annual savings: $7,790 + $6,332 + $2,731 = $15,853. Therefore, it costs $15,853 to buy down the interest rate and payments for three full years.

Benefits of 3-2-1 Mortgage Buydown

• The borrower qualifies for this loan at the 3.75% interest rate and payment amount of $1,670 versus the real rate of 6.75% and the payment of $2,270.
• Instead of the payment jumping all at once, it goes up in smaller increments, about $200 each year, for the first three years.
• It keeps payments low for 36 months for borrowers whose income is expected to later increase. Perhaps a spouse is returning to work after a hiatus or a person expects to graduate and land a higher paying job with that newly earned degree.

The 2-1 Buydown Mortgage

• This is a 30-year fully amortized mortgage.
• The interest rate increases 1% every year for the first two years.
• Then the interest rate is fixed for the remaining term.

Here is an example. Say your loan balance is $350,000 and the interest rate is fixed at 6.75% for 30 years based on 90% LTV with a sales price of $3898,888. The seller (or you) could "buy down" the interest rate by paying a lump sum of $8,063. This is how it works:

1. First-year interest rate is 4.75%, payable $1,826 per month
2. Second-year interest rate is 5.75%, payable $2,043 per month
 

• First-year savings (as compared to $2,270 per month) is $444 per month or $6,332.
• Second-year savings (as compared to $2,270 per month) is $228 per month or $2,731.

Add up the annual savings: $6,332 + $2,731 = $8,063. Therefore, it costs $8,063 to buy down the interest rate and payments for two full years.
 

Benefits to the seller.

For the Buyer to achieve a payment of 1,621 per month without a buy down, the seller would have to lower the asking price $111, 196. The seller would have to lower the asking price to $277,692. The buyer would get a 90% LTV loan or $249,922.  The payment for a $249,922 loan at 6.75% for 30 years is $1,621.  This example is using a low original asking price of $388,888. So imagine that if a seller would have to lower the price by $111,196 on a $388,888 asking price, just think of what the seller would have to lower the price too with a skiing price of $600,000 or more.  The message to the seller is, DON’T LOWER YOUR ASKING PRICE WITHOUT TRYING A BUY-DOWN.

A buy-down benefits all parties to the transaction. The lender still receives the full payment. The buyer receives a lower payment the first few years and lower interest payments. The cost to the seller is a lot less than lowering their price.  Of course this all works best if the seller has set an original sales price that is market. It is not selling because of that price.