July 1, 2007 Use a buydown to lower your rate

www.santacruzhomefinance.com

Mortgages come in all sizes and variations. The spectrum ranges from adjustable-rate mortgages that have low initial interest rates and low payments to the popular 30-year fixed-rate mortgage that has the highest interest rate and requires the highest payments. On the one hand, it is the stability of the 30-year fixed rate that makes these loans so popular but it is the temptation of low rates that draws borrowers to the adjustable-rate mortgages.

The mortgage industry came up with a loan program that marries these two extremes. It is called a Temporary Interest Buydown and combines relatively low initial interest rates with the long term stability of the fixed-rate mortgages.

The amazing thing is that these buydowns have been around forever. When I bought my home in Santa Cruz in 1989, the 30-year fixed rates were on the order of 10-11 percent. In order to make my house payments more affordable in the beginning [while I was building my mortgage business] I structured an interest rate buydown for myself.

Here's how that worked: The interest rate was set at 9 percent for the first year, 10 percent for the second year and then it would have gone to 11 percent for the remaining 28 years. I paid $207,000 for that home, put 20 percent down and borrowed $165,000. My payments for the first year were $1,327 per month, $1,448 for the second year and then would have gone to $1,571 for 28 years had I kept the loan in place. I saved more than $200 per month utilizing this buydown and that made a lot of difference to my budget back in those days.

Borrowers who are looking for a 30-year fixed rate but are balking at the payments based on the current rates, which are hovering in the mid 6 percent range, should consider an interest rate buydown. Your mortgage payments would be set in the 4 percent range for the first year. For a $600,000 mortgage, that could mean the difference between paying $3,800 per month or paying $3,000 per month.

Lenders require compensation for these lower payments because there is no free lunch. The "savings" that are enjoyed through lower payments for the first two years must be paid by either the seller or the borrower. In the example of the $600,000 mortgage above, the "cost" of the two years of lower payments would be $13,644. The buyer could ask the seller to pay this portion of the closing costs or the borrower could pay it in cash at the close of escrow or the lender could pay it in exchange for a higher interest rate [which the borrower ultimately pays for via higher payments for the life of the loan].

It was a hot seller's market when I bought my home in 1989 [right before the earthquake] and sellers did not need to make their properties more enticing by offering to pay for closing costs or buydowns. It is certainly different today. Today's sellers should be more than happy to make their homes as affordable as possible to prospective buyers. This buydown is an excellent tool that sellers and listing agents can use to make their homes more marketable.