Let's Talk: Buy Downs
When the real estate market stumbles, slows, or goes through any type of shift, it's a pretty well known fact that a couple of things are about to happen:
- lenders are going to get creative
- inexperienced (or ignorant, or slimy) professionals in the real estate and mortgage space will offer potentially really bad and costly advice on how to cope with the market shift
Cue the "marry the house, date the rate!" crowd. Great idea, until the rate you're dating knocks you up and you're stuck with it for 18 years. I digress...
In recent weeks and months, the "buy down" has made a resurgence to the lending world and in mortgage advertisements, agent presentations, and 'coffee meetings' everywhere.
What is a buy down?
Simply, a buy down is either a permanent or temporary reduction in mortgage interest rate in exchange for additional fees paid up front. In the current environment, most lenders require these fees to be paid by someone other than a borrower - ie a real estate agent from their commission, or more likely, a seller in the form of seller concessions perhaps in lieu of or in addition to a price reduction (we see the resurgence of buy downs in markets that are leaning more in favor of buyers). Builders or other involved 3rd parties can also contribute to buy down costs. It's important to note that permanent discount/buy downs can be paid by a buyer through 'discount points'.
A temporary buy down, which is what we're seeing more these days, comes in the form of a 3, 2, or 1 year temporary reduction in rate - for example, a 2/1 buydown would have a borrower paying an interest rate 2% lower than current market rates for their first year of mortgage payments, 1% lower their second year, and in the third year, the loan would revert to the note/market rate. So if rates are 7% today with no points, a 2/1 buydown would offer a borrower a 5% rate for their first year, a 6% for their second year, and then the 7% note rate would kick in in the third year and beyond.
It's a no brainer, right?
Not so fast. Like literally every mortgage product on the market, the temporary buy down offers some benefit to some people, but it has some cons that no one seems to want to discuss today.
Perhaps the biggest drawback to a buy down is the temporary nature of it - sure, having a rate 2% below current market is great, but let's say a refinance opportunity presents itself in the next 12 months - sure you save money during the first 12 months, but you lose the entire benefit of the 2nd year's reduced rate if you refinance during year 1. And while a buy down may offer temporary savings, it lacks the permanent/long term benefits of a price reduction or seller concessions. And while a temporary buydown may offer greater monthly savings for now, a permanent buydown, while offering less savings on a monthly basis, offers more savings over the life of a loan; but even that is assuming you'll have the loan for the life of the loan and never refinance or sell your home.
So what to do?
A temporary buydown is a great idea if the immediate monthly savings would offer you more benefit than the lesser, but more permanent savings that a price reduction might offer. If you can afford the monthly payment at current market rates without issue, there may be better strategies that save you more over time than a temporary buy down would.
Buyers today should be aware of and able to afford their "worst case" payment - that is, if a buyer gets a mortgage with a temporary buy down, they should enjoy the monthly savings, but be sure they can afford the payment when it increases.
Anyone working with a lender, loan officer, or agent who promotes the "temporary" nature of a buydown, or says things like "date the rate", should consider finding a better professional to work with. Why? Because while nearly all forecasts point toward recession in the near future, and opportunities to seize lower rates before long, a financial move as big as a mortgage and home purchase shouldn't take place based on what "probably" will happen. In 2019, there "probably" wasn't going to be 3 straight years of a global pandemic and international war effort wreaking havoc on the market place. No one knows what the next year, 2, or 3 will hold, so the strategies discussed when buying a home and choosing the right mortgage product should be based on sound finance, certainties, and 'worst case' scenarios.
Buy downs can offer tremendous financial benefit to a home buyer, and can also save a seller money (often a buy down will both be cheaper than a planned price reduction AND offer a more beneficial immediate impact to a buyer, making it a great way for a seller and buyer to both win when agreeing on contract terms). It's important, though, to know the ins and outs, and consider total costs, potential losses, and what a refinance in the near or distant future would add to the equation. A good loan officer can walk you through those considerations to help make the best decision. These conversations should also be had before a buyer starts making offers - a sound strategy up front ensures that the buying process is seamless for both the buyer and potential sellers (and their agents!).
For questions on buy downs, more info, or to get started on the home buying process, give me a call at 484.680.4852 or visit https://www.jmloans.com/
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