With the prices of homes today, a temporary buydown may be worth considering. Depending on your circumstances, it may be just what you need to ease into homeownership.
What is a buydown? A buydown is a reduction in your monthly mortgage payment in the first two or three years of your loan. What you are essentially doing is paying down your rate for a specific period of time. The interest is paid upfront by the borrower or the seller and put into an escrow account held by the lender. The funds from that account are used to supplement the difference in your monthly payments between the bought-down rate and the current market rate. At the end of the buydown period, your rate will remain fixed at the current market rate for the remainder of the term. Buydowns are not a separate product offered by lenders but a feature or a tool offered on fixed-rate mortgages to reduce your mortgage payments.
Who are good candidates for a temporary buydown?
Who wouldn’t want lower monthly payments for the first couple of years? A lower monthly payment will assist you in the early years of your mortgage to get you acclimated to making a new housing payment.
Let’s take a look at Lauren and Ed. They are a young couple who are planning to get married within the next year. Ed already graduated from college and is working as an engineer for an aviation manufacturing company. Lauren, on the other hand, is still in nursing school. She has a year and a half to go until she finishes her schooling and takes her state licensing exam. A buydown is perfect for their situation because it allows Ed and Lauren to make lower monthly mortgage payments while temporarily living on one income. Once Lauren starts working, their household income will increase substantially, and their payments will be easier to make. They also get the benefit of affording “more” for a house, because the lender will qualify them at a rate 2.00% lower than current market rates. They have the ability to purchase the house they want now, instead of having to wait until Lauren finishes her education.
Buydowns are also beneficial to those whose income may be on the lower side right now but is expected to increase within the next couple of years. Perhaps a borrower is currently working an internship or is up for a large promotion in the near future.
The advantages of a buydown are as follows:
1. It allows the borrower to make lower payments for the first couple of years.
2 .Borrowers may be able to qualify at the first year’s monthly payment, which
will help increase their initial affordability.
3. There may also be significant tax savings involved by being able to deduct
the cost of the buydown.
Who pays for the cost of the buydown?
A buydown is usually funded by the borrower or the seller. If borrowers have excess cash but lower income, they may opt to buy down their rate. It is common in today’s market for the seller to pay for the buydown as well. In cases where sellers have a house on the market that they need to move quickly, they may advertise that they will fund the cost of the buydown to make it a more attractive sell. This method may turn out to be less of a cost for them, rather than reducing the price of their house by $10,000.00 to generate more activity on their listing. In some cases, the cost can be paid for by both the buyer and the seller.
One of the disadvantages of considering a temporary buydown would be the cost associated with it. As you can see by the example, the cost of a buydown on a $250,000.00 would be approximately $ 5,618.00, a significant amount of funds to come up with. If a potential buyer does not have these extra funds available or the seller is not willing to contribute to the cost, a buydown is not possible. The buydown feature, therefore, would not benefit someone who is working with limited funds and is looking to purchase a property where the seller is unwilling to negotiate the price to fund the cost.
Another factor to consider when looking at a buydown option is that no matter what, the payment will increase over a two- or three-year period of time. Buyers must realize that the lower payment is only temporary. They have to be prepared to handle the increases in the second or third year. In other words, don’t get too comfortable making the lower payments.
When looking at all your options, a buydown may be just what you need to jump start homeownership.
Buydown Example
Loan Amount $250,000.00
Note Rate 6.25%
30 Year Term
| Year |
Rate |
Payment |
Monthly Savings |
| 1 |
4.25% |
$1,229.84 |
$309.45 |
| 2 |
5.25% |
$1,380.50 |
$158.79 |
| 3 |
6.25% |
$1,539.29 |
|
Cost of buydown paid up front $5618.00