In the last segment we introduced the concept of a temporary buydown as well as indicating that the cost of this loan will correspond to the cost of the lower payments over the period of the buydown. We begin the second part of our series by taking a look at an example of calculating these additional costs.

If one did not have the cash necessary to pay for a temporary buydown, it is possible to finance the cost through a higher interest rate. For example, if we raised the mortgage’s fixed rate to 6.5% from 6.0%, there may be little or no additional points charged for the buydown as compared to a 6.0% fixed rate without a buydown. Of course, the buydown would start at a rate of 4.5%, rather than the 4.0% shown in the illustration. In this case, we would be permanently buying up the interest rate of the mortgage in order to buy it down for two years.

Another option for paying for the cost of a temporary buydown is asking the seller to pay the cost as a “concession.” Since we are presently in a buyers market and so many sellers are anxious to sell their homes, it makes sense that a seller would be willing to pay the cost of a buydown. In essence, the seller is offering a lower rate and a more affordable payment on the home. This makes the home more attractive to potential buyers.

You certainly can see from the example that a seller would be much better off by offering a 2-1 buydown at a cost of 2.25 points (or 2.25% of the loan amount), as opposed to lowering the value of the house. On a $300,000 home, the cost would be less than $7,000 while many are slashing prices by $20,000 or more!

Temporary buydowns of fixed rate mortgages are poised to be especially popular during the next few years. At present, the starting rates of adjustables are relatively high as compared to fixed rates. Also, many lenders are making it more difficult for consumers to qualify for ARMs by qualifying them at rates that are higher than the initial rate of the mortgage. Finally, sellers are more willing to pay concessions in this market.

When fixed rates are high (say 7.0% or more) and short term adjustables such as one year or 3/1 adjustables are starting as low as 4%, we say that the spread is large or wide. When fixed rates are relatively low such as they are now and short term adjustables are still in the range of four to five percent–we say that the spread is narrow or small.

With a narrow spread, one may be able to utilize a 2-1 or a 1-1-1 buydown to achieve a starting rate which is almost as low as a one-year or 3/1 adjustable. Though the starting rates are similar,adjustables may increase as much as 2.0% in the first year as opposed to 1.0% for the buydown. Also, adjustables have potential long term increases that are as much as 6.0% as opposed to 2.0% for the buydown. Therefore, with a buydown you may obtain a similar short-term payment with longer-term safety.

Here are some examples of these choices–

• Fixed Rate at 6.0%, or One Year Adjustable–4.5% – Try a 4.0%-5.0%-6.0%
  (2-1 Buydown)
• 3/1 Adjustable–5.0%–Try a 5.5%-5.5%-5.5%-6.5%
  (1-1-1 Buydown)

It should be noted that the rules allowing a temporary buydown and the costs of such a buydown may vary from lender to lender. Also, some adjustable rate mortgages may permit a temporary buydown–for example a 5/1 adjustable, could be bought down 1.0% the first year. If you and your mortgage advisor are creative, there may be as many buydown alternatives as there are mortgage programs.