With home prices where they are these days the 2-1 buydown in loan programs are becoming increasingly popular. In a buyers market, such as the one we're in at the moment, you can even structure a buydown so that the seller pays for the buydown and closing costs. This means as a buyer you can expect a lower monthly payment with no out of pocket expense to close on the house. What a steal! The 3-2-1 program works the same way except it's over three years. I'll focus on the 2-1 program here for simplicity (you'll see why in the example I use).
The basic idea behind a buydown is to lower the monthly payment during the first few years of the mortgage. It is not to be confused with a discount point where you buy down the rate. Discount points are usually expensive, especially if you consider the break even point! I rarely advise borrowers to pay discount points, however, a buydown is a radically different concept and I would suggest you take advantage of it, if you qualify.
How does a buydown work?
Let's say you want to do a 2-1 buydown on a mortgage at 6.5% interest rate. In the first year your payment is calculated at 4.5%, 2 points below the 6.5% note rate. In the second year it is at 5.5%. Only at the beginning of the third year do you make payments based on the 6.5% note rate.
The payment difference is deposited in an escrow account at the time of close and is drawn from on a monthly basis by the lender. Here is an example of how this works:
Loan size: $200,000
Monthly payment at 6.5% (interest only) = $1083
First Year: Monthly payment at 4.5% (interest only) = $ 750
Payment shortage = $333 (this amount is forwarded to the lender from the escrow account)
Annual shortage = $3,996
Second Year: Monthly payment at 5.5% (interest only) = $ 916
Payment shortage = $167 (this amount is forwarded to the lender from the escrow account)
Annual shortage = $2,004
Total shortage over two years = $6,000 (this is the amount deposited in the escrow account)
6% seller contribution on a $200,000 purchase = $12,000
So if you can negotiate a 6% seller contribution you then allocate $6,000 to go towards the buydown and the remainder towards closing costs. Depending on your loan to value (LTV) and credit score you could even qualify for the loan at the lower rate! One caveat is that the loan program needs to allow 6% seller contribution, as not all programs allow such a high level.
Buydowns are great for first time homebuyers expecting increased income down the road or those in jobs with income variability. Make sure you're working with a qualified mortgage professional like www.tream.us, as you can see, it can get costly if you don't!
About Ted Blanchard