We are a week out from the Fed’s July 26th monetary announcement where predictions have rates hiking again. Current mortgage rates are reflecting the anticipated increase challenging affordability for the average buyer who is facing a mortgage payment 27% higher than last year at this time. The good news, options to create affordable solutions for the savvy buyers and sellers are still available.
Options to improve affordability
Historically we’ve managed through times of rising interest rates with mortgage programs incorporating rate buydown and adjustable rate mortgages. Programs that provide an affordable short-term mortgage solution to ride the wave of higher rates awaiting the cyclical downturn opening the door to a refinance. If a new home is on your wish list don’t let current market conditions delay your plan, get creative in the short term building equity for the long haul.
What is a rate buydown?
Rate buydown mortgage loans come in two forms, temporary and permanent.
- A permanent buydown is paid up front in the form of points and offers the borrower .50% to 1.0% below current market rates for the life of loan.
- A temporary buydown provides as much as 2.0% below current rates in year one, then adjusts up incrementally with payments returning to the fixed note rate for the remaining term of the loan upon conclusion of the buydown term.
How do temporary buydowns work?
The 2-1 rate buydown is the most common program and will be the focus as we compare options. Typically a seller sponsored incentive, the 2-1 buydown drops the borrower’s mortgage rate 2% below the note rate in year one and 1% in year two. Years 3-30 return to the note rate assigned to the loan at time of closing.
Buydown funds appropriated to cover the rate spread over the designated term are placed in escrow and paid out monthly. If rates drop during the buydown period making a refinance attractive or should the borrower choose to sell the property, the remaining funds held in escrow are applied directly to principal upon loan payoff.
Are qualifying criteria different for 2-1 buydowns?
These programs are available for owner occupied properties only and the borrower must qualify for the loan based on the note rate exclusive of the buydown term. The temporary payment reduction does not factor into qualifying. Seller contributions are capped and vary by loan type and down payment amount. The higher the borrower’s down payment, the higher the limit on the seller contribution.
2-1 rate buydown example
The example to follow compares four financing options for the same purchase price with the loan program being the variable.
The benefit for buyers and sellers
Fairway’s 2-1 buydown program is a cost effective temporary rate buydown helping buyers purchase today with lower monthly commitments. For sellers, it provides a way to differentiate their property by building the buydown into their price and positioning their home as a lower cost option in the short-term. Buying the rate down can save more over the early term of the loan than a comparable dollar amount in price reduction as shown above.
Who should consider using a buydown?
- Buyers seeking a lower payment during the first years in their home
- Borrowers anticipating and increase in wages in the near term
- Those seeking short-term affordability but not comfortable with adjustable rate loans
- Sellers seeking to attract buyers and avoid price reductions
How do 2-1 buydowns compare to Adjustable Rate Mortgages (ARMs) and permanent buydowns?
- 2-1 rate buydowns take a bigger bite out of the rate at 2% year one, then 1% year two.
- ARMs typically pull .25% to .50% off the rate for a fixed period (5, 7 or 10 years) then adjust annually after the fixed term. Combining an ARM with a permanent buydown is an option to drive a deeper discount for the fixed term of the ARM.
- Similarly, a permanent buydown takes roughly .75 to one percentage point off current market rates and remains at that rate for the term of loan. Unlike the temporary buydown, all monies committed to lowering the rate are applied in closing, not held in escrow and paid out monthly. Should a borrower seek to refinance in the short-term, there is no recoup of buydown funds.
Are we in an overpriced bubble about to crash?
If you’re concerned about a repeat of 2008, pause and pop over to our market update article offering some factual piece of mind. Real estate remains one of the most solid assets in any portfolio. Let us help make it affordable.
by Sheila Landis for The Landis Group
