# When payment matters: mortgage buydown programs

By
Mortgage and Lending with Phoenix Home Loan Expert (www.aimeeloans.com)

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.

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, as you can see, it can get costly if you don’t!

Chuck Christensen
Your Financial Coach - Bellingham, WA
Seems like a good way to get people into a house that they can't afford the full payments. That is the problem with Option ARM's. You forgot to mention that this is kind of a dangerous loan. Your counting on the client getting a substantial raise each year. I don't know anyone that has gotten that big of a pay raise unless it's a promotion also. You didn't address where that money goes that wasn't paid...is it a freeby because the lender likes me?
May 15, 2007 06:33 AM
Aimee Ghimire
Phoenix Home Loan Expert (www.aimeeloans.com) - Phoenix, AZ

Chuck,

Unlike the Option ARM or a regular ARM there is no dramatic rate increase when you do a buy-down as described above. The money shortage comes from the seller contribution and is deposited in an escrow account. As you can see the mortgage payment increases after the first year and eases back up to the regular rate. Again, this is not a product for everyone. This will work for a young couple where one is still in school and expecting to graduate in the next year or so but want to take advantage of current home prices. For people like these it's a great feature.

Again to reiterate this is not an Option ARM and the payments are not dramatically low to the point where changes can severely affect the ability of the borrower to re-pay the loan.

Thanks for comment.
Thanks,
Shailesh

May 15, 2007 09:41 AM
Doreen McPherson
Homesmart ~ Scottsdale ~ Tempe - Tempe, AZ
Phoenix Arizona Real Estate ~

Hi Shailesh,

Thank you for explaining this.

BTW, Kaushik posted a nice piece on meeting with you.  :)

Have a great week!

Doreen

May 15, 2007 11:27 PM
Aimee Ghimire
Phoenix Home Loan Expert (www.aimeeloans.com) - Phoenix, AZ

Doreen,

Thanks for letting me know!

Shailesh

May 16, 2007 04:54 AM
Anonymous
AmyLiz80
Thanks for the article.  We are considering a 3 2 1 loan as my husband is in school for the next year and a half.  It was very informative.
Jan 24, 2008 09:40 AM
#5