Interest rate buydowns can be used to entice home buyers to purchase homes even while the rates are increasing dramatically. Rate reductions can be purchased by buyers, sellers, lenders, agents or a mix of all of the above.
Interest Rate Buydowns May Be Added to the Sellers Toolkit
Have you ever heard of an interest rate buydown? If not, get ready, because this may be something we see more of in the coming months. With rates climbing well into the 5’s, buyers are struggling to wrap their thinking around the new monthly payment amounts. That said, the interest rate buydown could become a tool that sellers can use to entice buyers to purchase their home.
You may ask, what is an interest rate buy down? Good question! In order to better understand what a buydown is, let’s look at the two types of interest rate buydowns:
- Permanent Buydown
- Temporary Buydown
Permanent Interest Rate Buydown
The first buydown, the permanent interest rate buydown, is something I have heard my buyers talk about for years. Here is how they work.
Typically, banks will allow borrowers to “purchase” a reduced interest rate. A buyer might pay 1 point, or 1% of the loan amount, for each quarter percent of the rate buydown (check with your lender for amounts, terms and conditions.)
For example, say you are in the market to purchase a home for $500,000 (I know, that’s low, but let’s pretend for simplicities sake.) You put down 20%, that’s $100,000. That leaves you with a loan amount of $400,000. Let’s also say you want to buy your interest rate down to 4% for the 30 year life of the loan. For ease of understanding, let’s pretend interest rates are currently at 5%. That means you have to 4 points worth of interest rate reduction.
If we use the example above, 1 point (1%) for each quarter point of interest, then your equation would look like this:
- Loan amount of $400,000 x 1% = $4,000 per point
- Each point pays down 1/4 percent of the rate
- Four quarters = 1 whole percentage point of the rate
- $4,000 x 4 (points) = $16,000
That means, on top of your down payment and your closing costs, you need to bring an additional $16,000 to the closing. Sound great? I think so too!
Perhaps One of These Homes Would Work with an Interest Rate Buydown
Temporary Interest Rate Buydowns
Unlike the permanent buydown, the temporary interest rate buydown is a different product altogether. If you decide to use this loan strategy, please understand what you are getting into. Basically, the temporary buydown is exactly as it sounds. It’s temporary.
And the honeymoon isn’t long. From what I gather, the reduction tapers and ends in two to three years. So, why would a buyer elect to purchase a temporary loan rate reduction? Here’s why.
The borrower could be expecting a sizable increase in their income over the next couple years. Or, the borrower may be able to afford the higher interest rate, but isn’t ready to pay it quite yet. Whatever the reason, there are a couple ways this product can work.
Possible Seller Strategy – Buydown Contribution
a buyer, or someone else, can pay points to reduce the overall interest rate on a loan. In turn, the monthly loan payment will be correspondingly less.
As interest rate increase, sellers are feeling the hit. Many sellers are noticing a longer time on the market. Some sellers are trying to get ahead of the market slow down by reducing their home prices. Still other sellers are removing their homes from the market altogether.
Only the seller can make the decision to make concessions in advance. While some sellers are offering to pay for inspections up front, they may want to consider offering rate reduction buydown credits. These are all very good strategies when selling a home.
Rates Are Up Two Points in Less Than a Year!
Sadly, the days of interest rates under 3% are gone, at least for the foreseeable future. If you were lucky enough to get a fixed rate mortgage under 3%, please take a bow and consider yourself extremely fortunate! Though it may have seemed easy at the time, not all homeowners were able to take advantage of such luck. Things like income, credit score, and debt ratio were very important ingredients to your good fortune. You can and should be VERY proud. Congratulations!
In conclusion, if you are a seller or a buyer, consider the interest rate reduction. Whether a permanent or temporary decrease, both options are worth the exploration.