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When purchasing a home, it’s essential to have a solid understanding of the various mortgage options available in today’s market. With an expanding range of loan products, it can be overwhelming to determine the best fit for your unique financial situation. Let’s take a closer look at the highly effective and popular strategy of the temporary rate buydown, or sometimes simply referred to as a “temporary buydown.”
A temporary rate buydown allows you to subsidize (lower) the interest rate on your mortgage for the first 1-3 years of your loan term, which can help you ease into your new mortgage payment. Here’s how it works:
• The buyer receives a credit for a specific dollar amount from the seller, which the lender then holds in a separate account for the homeowner.
• The credit is applied to the buyer’s mortgage payments over the first 1-3 years, lowering their monthly payments during that time.
• After the temporary buydown period ends, the interest rate returns to the original rate for the remaining term of the loan.
There are three different types of temporary buydowns available, including:
• 3-2-1 buydown: This buydown reduces the interest rate by 3% in the first year, 2% in the second year, and 1% in the third year, before returning to the original rate in the fourth year.
• 2-1 buydown: This buydown reduces the interest rate by 2% in the first year, 1% in the second year, and 1% in the third year, before returning to the original rate in the third year.
• 1-0 buydown: This buydown reduces the interest rate by 1% in the first year and then returns to the original rate in the second year.
Let’s look at an example of how a 2-1 temporary rate buydown works. Suppose a homebuyer is taking out a 30-year fixed-rate mortgage at an interest rate of 6%. With a 2-1 temporary rate buydown, the interest rate can be lowered to 4% for the first year and 5% for the second year, and then it returns to the original rate of 6% for the remaining term of the loan.
In this scenario, let’s say the homebuyer purchases a home for $700,000 with a 5% down payment. The seller agrees to pay for the 2-1 temporary rate buydown, which would require a seller credit of $14,752.20. This credit would subsidize the buyer’s mortgage payments in the first two years, resulting in lower monthly payments. In the first year, the buydown would reduce the monthly payment by $812.20 per month. In the second year, the buydown would reduce the monthly payment by $417.15.
One important note is that the seller credit must cover the entire cost of the buydown. In this example, the entire cost of the buydown is $14,752.20, which the seller must agree to provide in the form of a seller credit. The amount of seller credit you are able to negotiate will dictate which temporary rate buydown options you can choose from.
Here’s one of the biggest perks of the temporary buydown – if the homeowner refinances or sells the property before the end of the temporary buydown period, the remaining seller credit is applied to the homeowner’s mortgage balance when the loan is paid off. This means that even if the loan is refinanced or the property is sold before the end of the temporary buydown period, the homeowner doesn’t “lose” the remaining balance of the seller credit!
The benefit of a temporary rate buydown for homebuyers is to ease their way into their new mortgage payment with a lower rate for the first 1-3 years, which can be particularly helpful for those who are increasing their housing expense. Additionally, this strategy can be especially useful for those who expect their wages to increase in the coming years, as they can take advantage of the lower payments now and then handle the higher payments in the future (or refinance if rates drop).
Although there is no perfect solution to address soaring real estate prices, utilizing a temporary buydown can be a smart and effective mortgage strategy for homebuyers to consider. By subsidizing the interest rate for the first 1-3 years, buyers can enjoy lower monthly payments and a smoother transition into homeownership.
If you’re in the market for a new home, be sure to explore your options for temporary rate buydowns and work with your mortgage broker (*raises hand*) to determine the best fit for your financial situation.
