Understanding mortgage rate buydowns
The 2-1 and 3-2-1 buydown terms have been popping up all over since interest rates increased last year. It is a great strategy that allows new homeowners to ease into a higher monthly payment.
The sellers of the home provide funds to the buyer to be able to lower their housing payments during the first few years of their new mortgage. The rate can be bought down for one year, which is a 1-0 buydown. The rate can also be bought down for 24 months, whereby the payments are 2% lower in the first 12 months and 1% lower during months 13-24.
Most home loans allow the sellers to help with the buyers’ closing costs. The buydowns are considered closing costs.
Looking at a 2-1 buydown with a full interest of 5.99%, the first 12 months would be calculated at 3.99%. The 13th through 24th payments are calculated at 4.99%. Then, starting with the 25th payment, the interest is calculated at 5.99%.
Based on a loan amount of $200,000 with a term of 30 years:
- 3.99% $7,980 / 12 = $665.00, total $953.68 principal and interest
- 4.99% $9,980 / 12 = $831.67, $1,072.42 principal and interest
- 5.99% $11,980 / 12 = $998.34, $1,197.82 principal and interest
The buydown cost is calculated by adding up the differences in payments:
$244.14 X 12 = $2,929.68
$125.40 X 12 = $1,504.80
In this scenario, the buydown equals $4,434.48, or 2.22% of the purchase price. This leaves more room for help with other closing costs.
Buyers in this example start with a payment of $953.68 vs. $1,197.82 for the first 12 months. During the second year, the payment is $1,072.42 vs. $1,197.82. Then with payment 25, the full interest rate is charged. The payment is $1,197.82 for the remainder of the term.
This strategy is a great way for buyers to ease into the full payments. Plus, if interest rates creep back down to lower levels, the buyer can choose to refinance at the end of two years or sooner. The added benefit would be the homeowners’ equity in their home would have appreciated.
Using this tool can help facilitate more closings.
