Would you ever try to solve an algebra problem if you didn’t know addition or subtraction? Or try to run a marathon if you’ve never run a 5k? The idea is you need to know the fundamentals before you can move on to more advanced challenges — and real estate (and mortgage financing) is no different.
If you remember back to last spring as rates started to rise, buydowns were all anyone could talk about, us included. 1-0, 2-1, 3-2-1, temporary, permanent — it could make your head spin. And how or when do you bring these options up to your client? Today we are going to learn the basics of buydowns, and next week we will tackle the question of the pros and cons of each type.
For starters, the goal of a buydown is to get a reduced interest rate for a period of time — as short as 1 year to as long as the life of the loan — in return for an upfront cost. That cost is the difference between what a standard (or par) interest rate monthly payment is vs the bought down (or reduced) interest rate monthly payment.
For example, this is what a buydown could look like with a $350,000 loan amount:
The standard par rate today is 6.875% resulting in a principal and interest payment of $2300/mo.
A buydown of 1% would be a payment calculated at 6.875%-1%, or 5.875% which is $2070/mo, or a difference of $230/mo.
Next, we need to understand the difference between temporary and permanent:
Temporary buydown refers to the temporary nature of the reduced monthly payment due to the reduced interest rate. In the example above, a 1-0 buydown refers to the interest rate being lower by 1% for a period of 12 months. After 12 months, the monthly payment is based on that non-reduced (bought down) rate. So using the example above, the payment is $2070/mo for 12 months and then reverts to $2300 for the remaining term of the loan.
Permanent buydown is different in that the lower interest rate is indeed set for the life of the loan. In this example, if the rate was permanently bought down for 30 years, the principal and interest payments would be $2070 for the life of the loan.
The cost associated with each option is based on the length of time of the buydown, temporary being the least and permanent the most.
Next week will focus on understanding why or when either of these options is more desirable than the other. All of this is to help demonstrate why having a lending partner who doesn’t just write loans but helps inform, educate and counsel on all the options available can be an incredibly powerful ally to you in this hyper-competitive market.
Reach out to a Key Mortgage loan officer today to learn more!
*This rate scenario is an example created for educational and illustrative purposes only. Posted rates do not constitute an offer to lend. All loans are subject to credit approval. Interest rates are subject to change due to market conditions. Please contact your loan officer for current rates.