Should You "Buy Down" Your Next Loan?
If the home you're looking at is just a little out of your reach, at least in the lender's eyes, or you want to gradually work your way up the monthly payment ladder, there's a little known mortgage program just for you. It's called the buydown.
There are two ways to "buy down" your mortgage rate: permanently and temporarily.
The Permanent Buydown
A permanent buydown is simply paying a little more in the form of discount points at closing to get a lower note rate. As an example, suppose you can find a 30-year fixed rate mortgage at 7 percent with no points. On a $150,000 30-year mortgage your payment would be $992.16 per month. If you're willing to pay 1 point at closing, you can then "buy down" the rate to 6.75 percent.
A discount point equals 1 percent of our loan amount, or in this case $1,500. Pay the point and your monthly payment drops to $967.45, saving you almost $3,000 over the next 10 years.
You can also look at this transaction this way: You paid an additional $1,500 at closing. You are saving $24.71 per month ($992.16 less $967.45). On a cash basis -- and without considering tax issues, the future value of money and other complexities -- you must live in the house for 61 months ($1,500 divided by $24.71) to re-coup your money. That's five years.
In this example, we have a "permanent buydown" because by paying 1 point at closing you have "bought down" the interest rate for the life of the loan.
The Temporary Buydown
Not all buydowns reduce interest rates for the life of the loan.
For instance, with a "3-2-1 buydown" we have interest rate reductions in the first and second years of the loan, but not thereafter.
Imagine that you can borrow $150,000 with a 30-year mortgage with 7 percent interest. With a 3-2-1 buydown, the rate for the first year would be 5 percent, or $801 per month. The second year rate of 6 percent results in payment of $894. Finally in years 3 through 30 the rate settles at 7 percent, or $992.16 per month.
In this example, the borrower saved $3,448 in the first two years of the loan. To lenders, that very same $3,448 is a cost which must be re-couped. Since $3,448 is equal to 2.29 percent of the $150,000 loan amount, lenders want points at closing to make up the lower rate.
There are other buydown combinations such as a 2-1, and even what's called a "compressed buydown" where the adjustments take place at 6 month intervals rather than 12.
When you hear about a loan with a start rate much below other mortgages, it's often a buydown. Indeed, builders often use 3-2-1 buydowns to entice purchasers.
What's the buy-down advantage? One benefit concerns qualifying. In most buydowns the borrower qualifies at 1 percent over the start rate. In the previous example, the initial interest rate was 5 percent in year one, so the qualifying rate would be 5 percent plus 1 percent or a total of 6 percent. And 6 percent is less than 7 percent.
Is this a big deal? For many borrowers, you bet.
Buydowns let you buy more house because you can borrow more with a given level of income. In this example, the required income to borrow $150,000 drops from around $38,000 to just over $34,000.
But if a buy-down lowers interest rates -- the good news -- but requires the payment of points at closing -- the bad news -- are borrowers really ahead?
In addition to qualification purposes, there may well be another reason purchasers benefit: If the seller pays some or all of the points, then the buyer gets the advantage of a lower rate without some or all of the payment up front.
Buydowns have advantages, especially if you can negotiate a seller "contribution." If you want to qualify for just a little more home or start with lower payments, think about buy-downs. They may just work for you.
No matter which broker, builder or seller, Rod Rawlings will help you with personal and professional services to find the new or existing home right for you.
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