If you’re like most people, you’ve probably never heard about temporary interest rate buydowns. It’s understandable since it can be hard to keep up with all of the loan products and features that may be available to you. This is why speaking with a qualified mortgage consultant to learn about your options can make all the difference.
Every borrower’s financial picture and future objectives are unique, so it’s important that you do your research when it comes to finding the most suitable mortgage product. It’s not only about available down payment funds, credit score, or available assets. Borrowers should also consider evaluating factors like their future potential for income increases and current cash flow needs.
Asking the right questions about your financial standing today, and what you expect your situation to look like a few years from now can help shape those decisions. A good place to start is to consider the following questions:
“Do I have enough saved for a downpayment?”
“Is my credit score strong enough to allow me to qualify for a mortgage?”
“If I expect my income to increase in the near future, is there a mortgage product to help me afford my monthly mortgage payment today?”
That’s exactly where an interest rate buydown can come to the rescue.
Interest rate buydowns have been around for years, but given the recent rise in interest rates, this loan feature may come in handy for borrowers seeking temporary rate relief and increased cash flow. It makes for an especially great pick for those who have the capacity for higher earnings within a few years of obtaining a mortgage, or expect an increase in their expenses, because it gives a temporary subsidy of the monthly mortgage payment.
What is a temporary interest rate buydown?
An interest rate buydown allows borrowers to receive a reduction in their original payment for an introductory period of time in exchange for an up-front cash payment. The payment is reflected as a fee that is paid at closing, which is paid either by the borrower or an interested party such as a builder, seller, real estate agent, etc.
The amount paid for the buydown is the difference in payment over the term of the buydown. For example, if the monthly payment without a buydown is $1000, and you bought down the rate to get an $800 per month payment for the first year, the buydown funds would equal $2400.00 ($200 per month taken off the mortgage payment for a year).
Homebuyers may potentially be able to use a temporary interest rate buydown to reduce their payment for up to two years. As mentioned above, it’s also important to note that these buydown funds don’t have to come from the borrower. Builders, sellers and other interested parties can potentially subsidize the buydown – although they may be subject to interested party contribution limitations, such as a cap on the amount they can contribute. Ask your mortgage consultant for specific details.
Why choose a temporary interest buydown in the first place?
The primary reason one might choose a buydown is to free up cash flow at the beginning of their mortgage term. For example, it’s likely that purchasing a home will require added expenditures such as furnishings, minor repairs or landscaping costs. Having a lower monthly mortgage payment through a temporary interest rate buydown can provide extra cash for those upfront homeowner expenses. Keep in mind that temporary interest rate buydowns are an entirely optional part of the mortgage loan. This means that the lender cannot elect to add this feature to the mortgage unless the borrowers specifically requests it.
How are temporary interest rate buydowns different than simply paying down discount points?
Generally, when borrowers buy discount points, they pay down their interest rate for the life of the entire loan. As the name implies, temporary interest rate buydowns are only available for the first couple of years of the loan, after which the interest rate adjusts to the original note rate. In other words, with a temporary buydown option in place, those rates are reduced for a set time period, with the length of that period depending on the type of buydown chosen by the borrower.
What types of temporary interest rate buydown products does loanDepot offer?
Our borrowers have several choices when it comes to appointing a buydown. Some of loanDepot’s most popular buydown options include:
1-0 Buydown – 1% interest rate benefit in Year 1, with the loan adjusting to the original note rate thereafter (Years 2-30)
1.5-0.5 Buydown – 1.5% interest rate benefit in Year 1, 0.5% interest rate benefit in Year 2, and the original note rate thereafter (Years 3-30)
2-1 Buydown – 2% interest rate benefit in Year 1, 1% interest rate benefit in Year 2, and the original note rate thereafter (Years 3-30)
These buydowns are available for purchase loans only and may also be available for borrowers who take out high balance loans in high cost markets.
When considering whether a temporary interest rate buydown might be right for you, it helps to run the numbers. Here’s an example of a 1.5-0.5 interest rate buydown:*
The chart above shows that with this particular loan scenario, the borrower would be able to reduce their monthly mortgage payment by $263--that’s over $3,000 in the first year!
Subsequently in Year 2, the borrower can still benefit from a reduced mortgage payment of $90 per month (that’s over a $1,000 in the second year). Add up the total benefit, and you’ll end up with over $4,000 for two full years.
To put that into perspective, having an extra $4,000 over a period of two years could potentially cover other bills such as cable, gas, water, and/or electric. This option can really make a substantial impact to those borrowers who need to free up as much cash flow as possible (especially if they can agree for the original up-front cash payment to come from a seller or builder). The beauty of this benefit is that the extra monthly cash can be applied to cover essentially any expense!
How can you tell if an interest rate buydown is right for you?
In order to decide whether a buydown will suit you, ask yourself if you have some extra money you can pay at closing to give yourself a break when monthly payments start coming due. Paying a few hundred dollars less per month over the first couple of years may come in handy if unexpected expenses creep up.
Even better – if some other party pays for the buydown on your behalf, that is money you stand to save outright. As you work with sellers or builders on your home purchase, it may be worth your while to investigate whether a temporary buydown could be part of the deal. Consult your mortgage professional about possibilities.
How do you choose the best temporary interest buydown option?
In order to find out which temporary interest rate buydown is best, home buyers should speak with an experienced loan consultant who can help break down the first few years of monthly mortgage payments to illustrate how much benefit a particular buydown option would provide.
Now that you understand how temporary interest rate buydowns work and how you could benefit from choosing one, think about whether this product type makes financial sense to your unique situation. If you feel that freeing up some cash through a reduced monthly mortgage payment could be a viable option, contact us today for additional details!
*The advertised loan is for a 30-year fixed loan with a 30-year fully amortizing term with a two year buydown benefit. The borrower required monthly payment is calculated using an interest rate one and a half percent (1.5%) below the note rate for the first year, and one half percent (0.5%) below the note rate for the second year. After the initial 2 year period, the interest rate will adjust to the note rate.
The actual interest rate, APR and payment may vary based on the specific terms of the loan selected, verification of information, your credit history, the location and type of the property, and other factors as determined by the lender. Rates in examples are shows for illustrative purposes only.
Loan scenario assumes a loan amount of $300,000 on a 30-year term. Rate of 5.000% (APR 5.058%) is fixed for the entire 30 year term, but the initial payments are reduced based on the buydown benefit. Buydown benefit for Year 1 is 1.5%, Year 2 is at 0.5%, and years 3-30 are no longer discounted.