You tell your real estate agent "I want to buy this house, how can I afford it?" It's the house of your dreams - the right number of bedrooms, a great kitchen, and a nice back yard. The problem: it's slightly out of your price range. What are your options?
One option you could choose that can help you afford to buy this particular house is to use the buy-down strategy.
The buy-down strategy is made up of two components. The first component is lowering the interest rate by paying points. One point is equal to 1% of the loan amount. Each lender usually has a matrix of rates and points charged. For example, the matrix might look like this:
8% 0 point
7.5% 1 point
7% 2 points
6.5% 3 points
6% 4 points
(rates presented are for illustration purposes only and are not a solicitation)
Paying more points up-front at the close of escrow means that you get a lower interest rate!
To implement part one of the buy-down strategy, the buyer would choose the lowest rate so that he would be able to afford to buy this house.
Part two of the buy-down strategy is to put language into the contract that requires the seller to pay these points as a credit toward non-recurring closing costs. Non-recurring closing costs are the fees that you pay only once at the closing table, and that do not get charged throughout the life of the loan. An example of a non-recurring closing cost is points!
Here is icing on the cake for the buyer: even though the seller credits for the points paid, the buyer may be allowed to deduct these points as prepaid interest (see Topic 504 from the IRS, and check with your professional tax preparer) in the year that the house was purchased! This could be a huge tax deduction for the buyer!
I have prepared a video example for you to see how this works. As you will see from this video, the buy-down strategy is a win-win for the seller and buyer. The seller opens the door to a larger pool of qualified buyers. The buyer is able to afford to buy the house he wants!