How does a reduction to your monthly payment the first couple of years you own your home without giving up the security of a fixed rate sound? If stair-stepping into your new monthly payment sounds interesting, read on!
A temporary interest rate buydown is a loan program that gives you a temporary reduction in payment for the first couple of years of your loan. Unlike an adjustable rate mortgage, a temporary buydown is a fixed rate mortgage — your payment change at a predetermined, set schedule.
Types of buydowns
Buydown terms are represented like this: “3-2-1 buydown” or “2-1 buydown” or “1-1 buydown”. Each numeral represents a 12 month discount to your rate and the number tells you how discounted your rate will be. By far, the most common is a 2-1 buydown, in which the rate is reduced 2% for the first 12 payments and 1% for the next 12 payments. After that, the rate stays at a steady level for the remaining term of the loan.
How does a buydown work?
The magic happens at closing. Techincally speaking, your rate and payment are fixed for the full term of your loan. At the time of closing a buydown subsidy fund is established. When you start making payments, your payment is subsidized and you get to enjoy a temporarily lower payment. Once the subsidy funds are exhausted, you pay the full payment.
The amount and duration of the discounted payment determine the amount of subsidy fund needed. Here’s an example of how the subsidy would look on a $500,000 loan with a 2-1 buydown.
Note: The monthly payments shown are principal and interest only and do not include taxes, insurance and any HOA dues.
$576 per month reduction in your payment for the initial year and $10,477 of savings over 24 months is significant!*
Funding the subsidy
The subsidy fund can be paid by the lender, buyer, seller. For a lender to fund your subsidy, you must pay a higher interest rate on your loan. Increasing your rate over the long-term to pay for a discount in the short term generally doesn’t make sense, so this is a seldom-used option.
A buyer-funded subsidy is a zero-sum game, financially speaking. If you fund your own subsidy, you will get back, over time, exactly what you put in. Even though this sounds a little pointless, there are circumstances under which you may want to fund your own subsidy anyway.
Seller-paid temporary interest rate buydowns are where things get really exciting. There is nothing bad about enjoying a lower monthly payment for a couple of years, paid for by your seller.
Why would the seller pick up the tab?
Of course, not every seller is going to be willing to pay the cost of a buydown. If your offer is one of ten on a hot property just listed yesterday, asking the seller to fund a 2-1 buydown is probably the quick path to a rejected offer. You’re more likely to talk a seller into funding a buydown on a home that’s been on the market a while.
Builders and buydowns
If you are thinking about buying a brand new home, you may be in the best position to ask for a seller-paid buydown. Builders will often go to great lengths to offer any sales concession but a price reduction. As for upgrades, as them to pay closing costs (or a buydown)… anything but a price reduction.
Why the allergy to price reductions? If a builder is selling 5 similar homes and you negotiate a lower price on one of them, they may as well lower the price on the other 4. Once you close, your purchase price will be recorded in public record. Buyers considering an offer on the remaining homes for sale will know the price you paid. Additionally, appraisers use “comparable” sales to determine property values for financing — a price reduction lowers the value for future sales. And any homes already sold are devalued too, which won’t endear the builder to earlier buyers who paid a higher price.
A temporary interest rate buydown is a way to get a sizeable and meaningful concession from your builder while keeping the sales price up.
Times to consider a buydown
There are as many reasons to consider a buydown as there are reasons you would want a lower payment for a little while. Here are a few we’ve seen over the years:
• You buy a new home and have to furnish it, landscape the yard and buy blinds.
• You expect a promotion and/or pay raise in a year or two.
• You’re finishing up a residency or will have your journeyman’s license in two years.
• You had a baby and have temporarily reduced your hours to care for your new family member.
• You will build an ADU at your new home and receive extra income once its done and rented.
• You are starting a side business that will generate extra income in a year or two.
• You are 18 months away from paying off your car or student loan.
Increase the amount you qualify to borrow
Some 2-1 buydown programs even allow you to qualify at the “bought down” payment. This could significantly increase the amount you qualify to borrow. Using the example above and assuming 20% down, qualifying at an effective rate of 3%, rather than 5% equates to $133,000 of additional buying power — a $625,000 house, rather than a $492,000 house.*
If you take advantage of a 2-1 buydown to increase your buying power, be mindful of the future payment. You don’t want to wind up stretched too thin as the payment adjusts up.
Why haven’t I heard of this before?
In the 1990s and early 2000s, temporary interest rate buydowns were fairly common. During the aftermath of the mortgage crisis, buydowns fell out of vogue. It didn’t help that as mortgage disclosure regulations changed there was a lack of clarity as to how buydowns fit into some of the new rules. Lenders largely stopped offering buydowns and people largely forgot they exist.
Guaranteed Rate offers buydowns program options
At Guaranteed Rate, we’re committed to offering a wide array of loan programs to serve the diverse lending needs of all of our clients — Including loan options with a temporary interest rate buydown. If you are purchasing a newly built home, we offer loan options with a 2-1 buydown on Fannie Mae and Freddie Mac and VA. We also offer a 2-1 buydown on a jumbo loan option up to a $650,000 loan amount.
We’d be happy to answer any questions you have about temporary interest rate buydown programs and whether they are a good fit for you. Email email@example.com or call 503-799-3711 for more information.
*Sample rates and buying power provided for illustration purposes only and is not intended to provide mortgage or other financial advice specific to the circumstances of any individual and should not be relied upon in that regard. Guaranteed Rate, Inc. cannot predict where rates will be in the future. Applicant subject to credit and underwriting approval. Not all applicants will be approved for financing. Receipt of application does not represent an approval for financing or interest rate guarantee. Restrictions may apply, contact Guaranteed Rate for current rates and for more information.
Guaranteed Rate, Inc. is a private corporation organized under the laws of the State of Delaware. It has no affiliation with the US Department of Housing and Urban Development, the US Department of Veterans Affairs, the US Department of Agriculture or any other government agency.
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