Buydowns are nothing new. I recall buying my first home in 1996. I wondered how I was ever going to be able to afford to buy that Condo on my entry-level salary. Enter FHA and a 3-2-1 buydown. At 7% my payment was supose to be around $1,385.00 per month. For the first year it was only $981.00. What a difference! Now I was told it would go up each year until it reached $1,385.00. I thought to myself I am only just entering this industry, I should earn more in the years to follow. It helped a great deal!
Buydowns and how they work
Buydowns allows for a lower interest rate on a mortgage for a fixed period of time, usually 1-3 years depending on the type of buydown. They are not a mortgage product but rather an interest rate reduction. The borrower is locked at the fully amortized note rate. For example, lets say the fully indexed rate is 7%. On a 2-1 buydown the interest rate will be reduced by 2% with a payment based on a 5% note rate. Typically for one full year. On the 2nd year in our example the note rate changes to 6% with a 1% decrease on the 13th payment. And again to 7% on month 25 through the remainder of the fixed rate portion of the fully amortized loan. The bank still makes interest on the loan at 7% from day one. You may ask how?
The borrower, in our example, is making a payment based on a 5% interest rate for a loan with a fully indexed rate of 7%. There is a 2% difference. This amount is stored by a third party escrow or held by the bank. When each payment is made the monthly difference is drawn and added to the borrower's payment.
Benefits of a Buydown
FOR BUYERS
- The interest rate is lower in the first few years giving buyers an initial lower payment.
- Reduces payment shock from renting to owning.
- Increases affordability, opening availability to more buyers.
- No unknown payment adjustments.
- Great for buyers who anticipate increased income in first few years.
FOR SELLERS AND BUILDERS
- Sellers can maintain their home price while still offering a competitive advantage.
- Gives "like" properties an edge by creating affordability and desirability through lower rate.
- Price Integrity: Builders can offer tremendous value by buying down the rate instead of discounting the home leading to unhappy homebuyers from previous sales.
Who Pays for a Buydown?
Typically the seller or the builder will pay for the cost as an incentive to the buydown. In some cases the buyer may pay for their own buydown. The buyer can pay also through the qualification process minimizing the need for out of pocket expenses. The cost of the buydown is simply the amount saved by the buydown.
Example: $300,000 Loan, 30 Year Fixed with a 2-1 buydown Fully Amortized rate of 7.125%.
Note rate 7.125% Payment = $2,021 (Full Payment)
- First 12 months Payment at 5.125% = $1,633 (Monthly Saving $338; Annual Savings= $4,656)
- Months 13-24 Payment at 6.125% = $1,823 (Monthly Savings $198; Annual Savings=$2,376)
- Months 25-36+ * Payment at 7.125 = $2,021 (no monthly or annual savings)
* Interest rate remains the same for the duration of the fixed rate term. For example on a 30 year fixed rate months 26-360 will be 7.125%. However on a 5 year fixed ARM months 26 through 60 will be fixed at 7.125% with 61 on subject to an ARM Product.
The total amount of the buydown is $4,656 + $2,376 (first 24 months savings) = $7,032. Also note that a seller contribution is capped between 2-6% depending on the property type and financing structure. The buydown is paid at closing and can be paid by the borrower or interested third party. A interested third party is anyone who has a financial interest in the property. Common interested third parties include Property Seller, Builder, Developer, Real Estate agent or broker.
FOR MORE INFORMATION PLEASE CONTACT ME AT andrew_clemente@countrywide.com. Countrywide has a number of buydown programs I would be happy to help qualify your borrowers or offer as an option for your sellers to maintain price intergrity.
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