Higher rates combined with higher prices create a challenging market for buyers and sellers. However, a particular form of seller credit, known as a seller-paid mortgage rate buydown, can improve the chances of a successful purchase/sale by benefiting both parties.
There are two types of rate buydowns, a Temporary Buydown (typically associated with Agency-Conforming loans), and a Permanent Buydown (can be for either Conforming or Jumbo loans).
Temporary Buydowns: Under this type of program the rate is reduced for the first 1-3 years of the loan. These programs are widely known as 3-2-1, 2-1 or 1 yr Buydowns. While the borrowers must qualify at the base rate- the rate that will be applicable at the end of the buydown period, the buyers will still benefit from lower payments during the initial period.
The rate reduction is usually 1% per buydown term year. Thus, if the base rate was 7.5%, then on a 3-2-1 Buydown program, the rate the first year would be 4.5%, 5.5% the second year, 6.5% the third, returning to the base rate of 7.5% the fourth year. A Temporary Buydown makes particular sense for the buyer if one assumes that rates will be dropping in the next few years.
The seller contribution cost calculation is straightforward- it is the difference between the total cumulative loan payments during the buydown period at the reduced rate and the total payments that would have been made over the same period at the base rate.
The advantage of a Temporary Buydown over a Permanent Buydown is that the interest rate reduction per dollar spent is much greater, but it is over a much shorter time (if the mortgage is retained for longer than the buydown period).
Permanent Buydowns: This option is not a special loan program. For a Permanent Buydown the seller is simply granting a seller credit toward the buyer’s closing costs to pay origination “points” on the mortgage to buydown the rate. One “point” equals 1% of the loan amount, and typically buys the rate down by 0.25%. However, as the points increase, the amount of rate reduction declines. Thus a 2- point buydown might get you a 0.50% reduction, a 3-point buydown may only deliver a 0.625% reduction in rate.
By temporarily or permanently reducing the housing expense for a buyer, a seller-paid rate buydown can be an attractive feature of a listing and may reduce any potential need for purchase price concessions to get a seller’s property under contract.