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Seller Buy-Down In Lieu Of A Price Reduction
When interest rates increase, fewer buyers can afford the payments associated with home purchases and fewer buyers can qualify and budget for the higher payments. When you factor in increased home values, buyers become priced out of the market. This is what causes the local real estate market to change from a “seller’s market” to a “buyer’s market”. Simply stated, buyers have interest rate, payment and budgeting objections that they do not have when interest rates are low. The solution to this problem is often to use buydowns to lower the buyer’s effective interest rate and mortgage payment and help them qualify.
A real estate agent or loan officer who has an excellent knowledge of how to use buydowns will be able to answer many of these buyer-related objections and help consummate the sale. When a home buyer says, “I’d love to buy that house, but the payment or interest rate is too high”, you should be able to say, “What payment or interest rate would you like? I’ll try to get you there.” Showing the buyer lower priced homes with fewer amenities is rarely a sufficient answer. An understanding of how buydowns lower the interest rate and the mortgage payment can help all involved. So here are the basics:
Lenders do not care what the interest rate is or how many discount points are charged to the borrower. They care what the combination of interest rate and discount points equals or yields. The total of the two is referred to as the yield.
On a 30-year fixed-rate mortgage, which is the standard loan most borrowers seek on home purchases, each discount point paid has a value of .25% interest. (A discount point is 1% of the loan amount, or $l,000 on a $100,000 mortgage loan.) Since each discount point paid to the lender in cash has a value of .25% interest, 4 points paid lowers the interest rate 1% over the 30 year term.
The buyer should be aware that when he makes an offer to buy, he is allowed to ask the seller for an amount which is considered to be a seller concession. This amount will depend on the type of loan the buyer is obtaining. It only takes 4 discount points to lower the interest rate one full percent on a 30-year fixed-rate loan. Six discount points would lower the rate 1.5%. With an interest rate of 6% and the seller paying 6 discount points the buyer would actually get 4.5% fixed for 30 years. It is a whole lot easier for the buyer to pay 4.5% interest than 6% and the payments are substantially lower and easier to qualify for. The seller could offer these lower rates instead of lowering their price by up to 6%. The seller would be getting full price and the buyer would receive lower interest rates.
The most common form of buydowns employed by lenders nationwide are called interest rate buydowns. These buydowns come in the two primary categories, permanent or temporary. A permanent interest rate buydown would lower the buyers interest to a fixed amount for the entire loan period. A common permanent interest rate buydown would be a 1% interest reduction for 30 years. The lender would require the seller to pay them an amount equal to approximately 4-5% (4-5 points) of the loan amount in cash at closing. In return, the lender would give the buyer an interest rate 1% below the market rate for 30 years. A temporary interest rate buydown could be for 36 months and would be as follows:
3-2-1 TEMPORARY INTEREST RATE BUYDOWN (over 36 mo.)
Note 7%/ $100,000 Loan 7%/ $100,000 Loan Mo. Savings Annual
Year Without Buydown With 3-2-1 Buydown Savings
1 $666 $477 at 4% $189 $2,269
2 $666 $537 at 5% $129 $1,548
3 $666 $600 at 6% $ 66 $ 792
4% after Yr 3 $666 $666 at 7% 0 $4,609
Gross buydown amount required to be paid by seller at closing = $4,609 which is equal to 4.61 points.
Note: The above payments are for principal and interest only and have been rounded off for simplicity.
Source: Elias/Skye
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