BUT – there is another solution for payment relief that is nothing short of awesome: TEMPORARY RATE BUYDOWNS, aka 3-2-1; 2-1; or 1-0.5 buydowns (NOTE: these are NOT just “paying discount points” for a lower rate).
How a 3-2-1 Buydown Works
For illustration purposes, assume we have a $100,000 loan and the market rate is 6.5%.
With a 3-2-1 buydown, the borrower would have a 3.5% rate in year one of the mortgage; a 4.5% rate in year two of the mortgage; a 5.5% rate in year three of the mortgage; and a 6.5% (today’s assumed market rate) thereafter.
In other words, the 3-2-1 buydown buys down the rate 3% in year one; 2% in year two; and 1% in year three.
Cost of a 3-2-1 Buydown
The cost of the buydown is simply the total of the principal and interest (P&I) not paid – via the normal payments over the first three years of the loan.
In the above scenario, the borrower is avoiding approximately $2,200 of P&I in year one; $1,500 of P&I in year two; and $800 of P&I in year three, so the total cost would be approximately $4,500. (I rounded the numbers to keep the explanation easier to understand)
For a $500,000 loan the numbers are very similar, but you would multiply the cost by 5, as a $500,000 loan is 5x larger than the $100,000 loan used in my example.
The other buydown options (2-1 and 1-0.5) have much lower costs for sellers, but less savings for the buyers, too.
Who Pays for the Buydown?
These temporary buydowns are not treated as traditional buydowns or discount points from a regulator’s perspective, either, so they must be paid for by anyone who is NOT the borrower. Generally, that would be the seller. But, Realtors could chip in with credits, too (not that we would ever suggest that to our clients).
The Beauty of the 3-2-1 Buydowns: 3% Interest Rates And Refunds When Refinancing!
There are several things that make these buydowns so beautiful!
- Low Rates/Payment Relief: They can easily give borrowers low rates (in the 3% range) and tremendous payment relief! A $500,000 loan at 6.5% has a payment of $3,160, but at 3.5% the payment drops to $2,245 (savings are $915 per MONTH!).
- Refi Is Likely: I have mentioned in numerous blogs that falling rates and refis are very likely sometime in the next six months – so buyers with 3-2-1 buydowns will often be able to refi long before their buydown periods end.
- Buydown Funds In Escrow/Get Refunded: This is the best part! The entire cost of the buydown gets put into an escrow account at closing, and any remaining buydown funds get refunded and applied to the principal IF buyers refinance before the buydown period ends.
- Sellers Pay! I mentioned this above but am mentioning it again because it is a major aspect of the beauty of buydowns.
Jay Voorhees
Founder | JVM Lending
(855) 855-4491 | DRE# 1197176, NMLS# 310167
