Rising mortgage rates have made home buying less affordable. The biggest burden falls on people who are struggling to purchase their first home and those trying to move up into more expensive one. One strategy for dealing with higher rates is to temporarily buy down the interest rate.
What is a buy-down and how does it work?
A buy-down is a mortgage financing technique in which the buyer pays extra cash at closing so that the monthly payment is based on an interest rate that is typically 1 percent to 2 percent below the note rate. The first-year rate on a buy-down is often referred to as the “start rate.”
How much does it cost to buy down an interest rate?
The cost to temporarily lower the interest rate on a mortgage loan depends on the size of the mortgage and the term of the loan. In general, the more money you borrow and the longer you borrow it for, the more it will cost you to buy down your interest rate.
For example, a borrower who wishes to obtain a mortgage for $400,000 and initially pay 4% interest (instead of 5%) may be able to temporarily reduce their rate by 1% by paying $4,000 for the buy-down.
What are the benefits of a buy-down?
Buyers may be concerned about the cost of home ownership, especially during the first several years. A temporary buy-down allows buyers to qualify for a larger mortgage and to have more money available during these years to handle increasing expenses. It also gives them time to adjust to their new monthly housing expense.
Why not just make a bigger down payment?
Borrowers who plan to sell their home in a few years or refinance to a lower rate may wish to use temporary buy-down options, such as using a seller concession or front-end points, rather than making a larger down payment or paying permanent points. This strategy maximizes interest savings during the initial years of the mortgage when funds are tightest.
Who usually pays for the buy-down?
Although the buyer benefits from a buy-down, the buyer is not always responsible for paying the buy-down cost. The seller, builder, or real estate agent can pay the costs to temporarily lower the interest rate.
Buy-downs are typically negotiated between mortgage lenders and home buyers. In general, buyers pay a predetermined number of points upfront in exchange for a lower interest rate on the mortgage. This makes their payments more affordable by reducing their monthly principal and interest payments, often for a specified period of time or over the life of the loan.
Sellers & Builders
Sellers may also offer to buy down a buyer's mortgage to incentivize the buyer to purchase their home. In these circumstances, the seller will make a one-time payment and deposit it into an escrow account or pay for points over the entire loan term as part of seller concessions.
A seller’s subsidy allows a buyer to make payments on a home loan at a lower interest rate, so that the buyer can afford their home loan. However, in exchange for this subsidy, the seller often adds the cost of the subsidy to the purchase price of their home.
How does a buy-down impact a loan qualification?
Fannie Mae, Freddie Mac, and the Federal Housing Administration require that borrowers qualify at the note rate. The Department of Veterans Affairs offers special qualification guidelines for VA loans: Qualifying based on the first year's payments is allowed if the borrower can provide "strong indications" of increased income in subsequent years. Such strong indications include confirmed future promotions or wage percentage increases guaranteed by labor contracts.
Buy-downs are a way to lower your monthly mortgage payment. Points paid at closing can reduce the interest rate on your loan, which can lead to long-term savings. However, not all buyers will benefit from buy-downs. You should calculate your breakeven point—that is, the amount of time it takes to recover the money spent on points—to ensure the upfront investment will pay off in the long run.
If you’re ready to move forward and discover the money-saving options available for you, apply now or contact a Soar Lending mortgage specialist at 727-310-0955.