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What is a temporary buydown and do you want one? We’ve mentioned here on several occasions about how the mortgage industry seems to think up different lending terms on a regular basis but that’s really not the case at all. Yet in this instance a temporary buydown isn’t promoted as often as perhaps it should be as most mortgage lenders don’t even advertise the product. In the proper situation, temporary buydowns can help someone qualify for a mortgage at the outset while preparing for the future at the same time.
What is a temporary buydown?
Temporary Buydowns: Temporary vs. Permanent
A temporary buydown is exactly what it means. It’s a buydown but only for a predetermined period of time. In the mortgage industry, there are two types of buydowns, a permanent buydown and a temporary. A permanent buydown is a way to lower the interest rate on a mortgage and the rate remains at the initial level throughout the life of the loan.
For example, let’s say a couple is considering a 30 year fixed rate loan of $300,000 and the loan officer is quoting a rate of 4.25% with no discount points. If you recall, a discount point is expressed as a percentage of the loan amount and is a form of prepaid interest to the lender. One point is one percent of the loan amount. On a $300,000 mortgage, one point is $3,000 in prepaid interest. It’s also called a discount point because the rate is lowered because the couple paid $3,000 in points upfront.
The lender has no preference one way or the other if a borrower chooses to pay points or not as the lender gets the interest either way. If the 30 year fixed rate was 4.25% with no points the borrower could pay one point and lower the rate to 4.00% where it remains throughout the life of the loan.
In this example, the principal and interest payment was reduced to $1,432 from $1,475 for a monthly savings of $43 as a result of paying a point. Lenders offer a range of interest rates on the same loan program based upon the number of points paid. A permanent buydown is available for any fixed rate program of any term ranging from 10 to 30 years as well as for hybrid loans where paying points lowers the initial start rate and lifetime cap.
A temporary buydown is referred to as a “2-1” or “3-2-1” buydown and takes a little math to figure out. The lender can offer a temporary buydown on most any fixed rate program by calculating the interest over the initial period.
A 2-1 buydown means the interest rate starts out 2% lower than the permanent rate for the first year, 1% for the second then resting at the final note rate for the remaining term.
A 3-2-1 buydown works in the very same fashion yet starts out 2% below the final rate, and so on. A 2-1 temporary buydown for example might be 3.50% for year 1 then 4.50% for year two and 5.50% for years three and beyond. The way it is calculated is providing the lender the difference in interest from year one to year two by adjusting the final rate.
For example, a couple is interested in a 2-1 buydown because they expect in a couple of years they will have their student loans paid off and will more comfortably afford the monthly payment but for now they’d like to take advantage of the lower rate.
With a 30 year fixed rate of 3.50% on $300,000 the principal and interest payment is $1,347 and at 4.50% the payment is $1,520. 5.50% the principal and interest payment is $1,703. Remember, this is a temporary buydown and the lender is still owed the difference between the final rate and years one and two. This difference is $4,890 in interest. The borrowers can pay all or part of this upfront to the lender or allow the lender to adjust the overall note rate to accommodate the deferred interest. In this example, that equates to about 1.625% either in points at closing or adjusting the rate a bit higher.
There are a couple of reasons why a temporary buydown might be a good option. The first is simply to help qualify. Lenders can qualify a borrower based upon the initial rate and not the final one. That helps qualifying for a larger loan amount but should be examined in light of future income and expenses. If a borrower qualifies at say 5.50% now and takes out a 2-1 buydown and starts at 3.50% it helps monthly cash flow but if the borrowers do not qualify at 5.50% a lender will probably have to provide another option.
Temporary buydowns aren’t as common as they used to be primarily because interest rates overall have been near historic lows for some time although many anticipate rates to continue their upward path throughout 2017 and beyond as the economy continues to improve. If y you’re looking at a fixed rate to finance your next purchase ask your loan officer to calculate a temporary buydown for you to see if the extra cash flow each month makes sense in your situation.
I was referred to Chad by my Realtor for a purchase of a new house. The experience with Chad and the team (I mainly worked with Juliann) was nothing short of outstanding. From start to finish there were always quick to respond and when needed, notify me of any new documentation that was required. There were very helpful explaining to me the pros and cons of different financing options as well as some other loan related issues, such as termite clearance outside the purchase contact and septic tank certification process. Overall, very knowledgeable and processional team. Loan preapproval was done in a single day and loan documents were ready for signing in 21 days, which was 9 days ahead of schedule. That never happened to me before.
“Chad and his team are exactly who you want handling the financing of your home. Whether it be a new purchase or refinance, he and his team are one of the most professional, responsive group of people I’ve worked with. Buying a home can be very stressful and Chad and his team took all of the necessary steps to make the process as painless and as quick as possible. They are extremely knowledgeable, organized and have great follow through. You won’t ever be left wondering what the next steps are. I highly recommend him and will use him in all of our real estate transactions moving forward.”