I have been reading some good posts with some great comments over the last few days. And this post, The Value of the Buydown by John Klassen, and the comments in this post, inspired me to write this blog. The reasoning behind this is because I would like to give some different view points, so not only consumers will understand, but realtors in general. I think this blog will tie in perfectly with the two previous blogs that I wrote a few weeks ago. PMI (Private Mortgage Insurance); why you need it and the different types of PMI......  &  The Myths about ZERO point mortgages instead of paying points upfront......

In this post, I am going to talk about the difference in buying down your rate and what an actual buydown is and how to utilize this to your advantage.

Even though John mentioned buying down the rate in his blog which is mentioned above, Leo Namiot brings up another good topic of discussion. The buydown, normally known as the 2/1 buydown. What Is a Temporary Buydown?

Sure, there are other versions of this, the 1/0 buydown, the 1 1/2/  ½  / 0 buydown, or sometimes the 3/2/1 buydown. This type of financing is not just buying down the rate, which would be fixed for that term, but possibly buying down the start rate low enough to qualify. But this rate will move each year, depending on the type of the buydown. Now, don't be afraid though. As a loan officer, I can tell you exactly what your principal and interest will be for each succeeding year while in this program. Some people think that these rates could go higher, depending on the market. This is not an adjustable, but just a lower fixed rate that will adjust as a fixed rate per year.

I will use the 2/1 buydown as my example, because it's easy to follow.  This will be based on a $200,000 loan amount with 10% down, which would mean that the purchase price was $222,250.  And the seller is going to contribute $5,250. I am going to stay with these same numbers when I discuss this further in Part 2 of this series.

At a rate of 6.00% fixed for 30 years, which at today's market, would be a zero point loan.  If I did a 2/1 buydown, it would cost the borrower 1.375 pts which would be $2,750, leaving the client $2,500 for other closing costs. And using this 6% buydown, the first year rate would be 4%, the 2^nd year at 5%, and the 3^rd year fixed for the remaining 28 years would be at 6%. The payments would adjust to whatever the principal is remaining after the first year in accordance with that years rate. I am not going to complicate matters, but for those money geeks that Brian Brady refers to, each buydown is different when calculating when it adjusts. Sometimes it will adjust after the 13^th or 14^th month. But to keep this simple and for simple math purposes, let's assume that each year, the adjustment period is 12 months. And remember, these rates will not change no matter what the market does before each adjustment period. This is written into your note addendum.

Example A - Fixed Rate & buying down the fixed rate

So, at 6% on 30 year fixed rate, your P & I payment would be : $1,199 per mo

Now, if I took that $2,750 that it cost for the 2/1 buydown, but applied it to the rate, my new rate would be 5.625%, fixed for 30 years, no buydown.

                                                      Your new P & I would be: $1,151 per mo

A new savings of $48/ mo. After 3 years, your savings would be $1,728. But it cost you $2,750 to do the fixed rate, meaning that it cost you $1,022 to still do the fixed rate.

Example B - 2/1 buydown

    2/1 buydown:  1^st year at 4%, your P & I payment would be : $  954  Savings of $245/mo

                         2^nd year at 5%, your P & I payment would be: $1,070 Savings of $129/mo

                         3^rd year at 6%, your P & I payment would be : $1,189 Savings of $ 10/mo

So your 3 year savings would be a total of : $4,608. You spent $2,750, so your savings after doing the buydown would be : $1,858.

After comparing the fixed rate, if you bought it down, & the 2/1 buydown,  the difference would be that you saved $2,880 in a 3 year period. But one thing happens from here on out and that is your buydown payment is $38 more a month for the remaining years that you hold onto this mortgage. And we haven't even talked about what your principal balance would be after the 3 years on either scenario.

Your principal balance on the fixed rate that was bought down would be $191,636 after 3 years. Your balance on the buydown would be $190,637 after 3 years. There is close to a $1,000 difference, in favor of the buydown. But again, remembering that your payment is now $38 more a month. [GOALS]

In summary, this is where goals come into play. Here are two posts that talk about goals just as a reminder to the clients buying. Outline your intentions, Make a list of what you want and get it., by Christine Adler &  Don't Lose site of your goals!, by Dwayne Neufeld.  As a client, have you done your homework?  That is what a good loan officer is there for, to not only get you a good deal, but to help you understand your options. And how I proceed with this is that I ask the client within the first 5 to 10 minutes, what their goals are, as they buy this house. Yes, their goals. Not everyone can predict their future, but many people buying a house know if it's their starter home, if they will be in it for 5 to 10 years, or that they will want to stay there for the rest of their lives. And there are even times when they might want to pass their house down to their kids. Again, sure, we can't predict the future, but when buying a house, these clients should have goals already.   

Once I get a good feel for what my clients goals are, what they want to achieve while living in this house, I can then proceed to the 100's of types of mortgage programs. In my second segment (Part 2), I will discuss the possibility of using that money to buy down the PMI, instead of using it for the buydown. You might be shocked at what this could do for your monthly payment. Even throwing a twist into the whole mix by using some of the money for the buydown and the rest for the PMI will be shown. And not forgetting that this scenario was based on putting 10% down which would require some type of mortgage insurance. So, we aren't finished comparing apples to apples yet.