Interest Rate Buy Downs - Back To Mortgage Programs
A buy down is a mortgage financing technique where the buyer attempts to obtain a lower interest rate for at least the first few years of the mortgage.[1] The seller of the property usually provides payments to the mortgage lending institution, which, in turn, lowers the buyer's monthly interest rate and therefore monthly payment. This is typically done for a period of about one to five years. In a seller's market the seller might raise the purchase price to compensate for the costs of the buy down but in most markets it would not be to their advantage to use a buy down as an enticement if they are going to offset the benefit by raising the price.[2] In most cases, the buy down does not even involve the seller. It is an arrangement between the lender and the buyer.
You may also use the buy down option on a refinance.
The most common buy down is the 2-1 buy down. In the past, for a buyer to secure a 2-1 buy down they would pay 3 points above current market points in order to pay a below market interest rate during the first two years of the loan. At the end of the two years they would then pay the old market rate for the remaining term.
As an example, if the current market rate for a conforming fixed rate loan is 8.5% at a cost of 1.5 points, the buy down gives the borrower a first year rate of 6.50%, a second year rate of 7.50% and a third through 30th year rate of 8.50% and the cost would be 4.5 points. Buy down costs were usually paid for by a transferring company because of the high points associated with them.
In today's market, mortgage companies have designed variations of the old buy downs rather than charge higher points to the buyer in the beginning they increase the note rate to cover their yields in the later years.
As an example, if the current rate for a conforming fixed rate loan is 8.50% at a cost of 1.5 points, the buy down would give the buyer a first year rate of 7.25%, a second year rate of 8.25% and a third through 30th year rate of 9.25% , or a three-quarter point higher note rate than the current market and the cost would remain at 1.5 points.
Another common buy down is the 3-2-1 buy down which works much in the same ways as the 2-1 buy down, with the exception of the starting interest rate being 3% below the note rate. Another variation is the flex-fixed buy down programs that increase at six month interval rather than annual intervals.
As an example, for a flex-fixed jumbo buy down at a cost of 1.5 points, the first six months rate would be 7.50%, the second six months the rate would be 8.00%, the next six months rate would be 8.50%, the next six months rate would be 9.00%, the next six months the rate would be 9.50% and at the 37th month the rate would reach the note rate of 9.875% and would remain there for the remainder of the term. A comparable jumbo 30 year fixed at 1.5 points would be 8.875%.