In the past year, the real estate boom has slowed and many potential sellers have had difficulty marketing their properties. Previously, the primary alternative used to get potential homeowners qualified for a home was adjustable rate mortgages. In this era, many lenders have tightened guidelines for adjustables while the rates on these loans are not as attractive as fixed rates. The slow economy has kept mortgage rates low and the fact that we have low fixed rates also makes viable a great alternative to adjustables–temporary buydowns. These buydowns can help get homes sold at a cost that is much less expensive than discounting the price of the house.
For those who are facing risingpayments on their adjustables or are considering financing for the first time, it may make a lot of sense to take a second look at an alternative that was notpopular during the real estate boom, but has been used to spur home sales for decades. This current environmentdictates a much closer look at temporary buydowns as a significant financing tool.
Many prospective home purchasers are finding that temporary buydown loans achieve lower payments during the first few years of their mortgage without experiencing the long-term risks of adjustables. Since the underlying mortgage of a temporary buydown is typically a fixed rate, there is no risk of longer-term rate increases. The fixed rate characteristic of the loan takes over after an early period of scheduled rate increases typically no greater than one percent each year.
The term buydown refers to lowering the rate of a mortgage. The term temporary buydown refers to lowering the mortgage’s rate for a specific period of time. For example, a temporary buydown of a six percent 30-year fixed rate mortgage might exist as follows:
5.0% for the 1st year (payments 1-12)
6.0% for the 2nd to 30th year(payments 13-360)
We would refer to this example as a 1-0 (one-zero) buydown. It is so named because the interest rate is lowered, or bought down, one percent the first year and is not lowered in subsequent years. The most common temporary buydown presently available is a 2-1 (two-one) buydown (see the inset chart below–
6.0% 30-Year Fixed Rate
4.0% for the 1st year (payments 1-12)………………….2.0% buydown the 1st year
5.0% for the 2nd year (payments 13-24)……………….1.0% buydown the 2nd year
6.0% for the 3rd -30th year (payments 25-360)………..0% buydown 3rd-30th year
Why would someone choose a temporary buydown? Borrowers typically would look for a lower payment during the first few years of the mortgage term in order to achieve the following objectives:
- The lower payment may help them qualify for a home where they could not qualify under other financing alternatives.
- The purchaser may be able to afford this home in the short run and if their income is expected to increase in later years, they will avoid the need for a second purchase in order to trade up.
- With purchase and moving costs, the first few years of a mortgage are typically the most difficult to absorb. Higher payments may be easier to weather after the initial costs of homeownership are incurred.
What are the costs of a temporary buydown?
It is not likely that the lender will lower the payments on your mortgage for a few years without charging higher fees which are known as points. One point is equal to one percent of the loan amount (One point charged on a $100,000 mortgage would be equivalent to a cost of $1,000). The borrower may pay these points up-front in cash, or may finance them through a higher interest rate during the later years of the loan. The questions remains–how much will this cost a borrower?
Calculating the costs of a temporary buydown is quite easy. The costs will be roughly the same as the benefits of lower payments received during the buydown period. In the next segment we will take a look at an example of calculating these expenses, as well as looking at how this buydown can help a seller make a home more attractive to potential buyers whilelessening the need for discounting.
