Ways Buyers are getting below market interest rates, Part 1 of 3: Interest Rate buydowns

It’s no secret that mortgage rates have gone up a bunch. We keep going back and forth, teetering around that 8% mark at the writing of this post.

With the increase in home prices combined with these interest rates, it’s pushing many people to throw their arms up and just say, ‘nevermind, this just isn't for me.’ 

But ladies, I want to encourage you out of that way of thinking. Here at Home Buying for Women, we’re all about finding creative ways to help you achieve your goal of homeownership. 

So let’s get to it.

The first way you can leverage the market to your advantage is by getting the sellers to pay for an interest rate buy-down for you.

What is an interest rate buy-down?

Here’s how this works. 

When you start the process with a lender to find out how much of a home you can afford, that will be based on the interest rate that you qualify for at the time. Today, a lender might tell you that you can get a loan of up to $250,000 at an 8.25% interest rate.

So that’s your max budget. If you’re putting 10% down, then that would mean you’re shopping for a house up to $277,777.

You find the home for that price. If you bought that home with no buydown, then your monthly principal and interest payment for that $250,000 loan at 8.25% would be $1,877.07. 

Then you have your Realtor negotiate a 2-1 rate buy-down for you. The sellers agree to this and that saves you $339.01/month in year one of your mortgage and then $172.81/month in year two of your mortgage.

Your savings over the first two years of that loan will total $6,141.85.

The way this works is the sellers pay the difference in the interest rate for those first two years so that you’re paying 2 points less for the first year of the mortgage and one point less on the second year of the mortgage. 

So since in this example, your $250,000 loan is at an 8.25% interest rate, for the first year of owning the home, as the buyer your mortgage payment is such that your interest rate is only 6.25%. So you’re actually only paying $1,538.06 for the principal and interest portion of the loan in year one of the mortgage. The seller pays for that $339.01 monthly difference.

For the second year of owning the home, as the buyer your mortgage payment is such that your interest rate is only 7.25%. So you’re actually only paying $1,704.26 for the principal and interest portion of the loan in year one of the mortgage. And for year two, the seller pays for that $172.81 monthly difference.

There’s also a 3-2-1 buydown that works the same way but has the interest rate in your first year going down to 3 points below. So year one you’d be paying at an effective mortgage rate of 5.25% which would put your principal and interest payment at $1,379.25.

Now the cost to the seller almost doubles with a 3-2-1 buydown. It was previously a total expense of $6,141.85 with a 2-1 buydown but the 3-2-1 buydown turns it to being $12,115.64. And before you count on a 3-2-1 buydown, you’ll want to be sure this amount of a credit is allowed by your lender. So, again, back to me reminding you to go into this with a great lender who knows how to do this.

Here are the frequently asked questions with an interest rate buy-down:

Why would you buy down the interest rate?

This is a great way to get into a home now at today’s prices and temporarily reduce your monthly cost of homeownership. It can help you free up cash to add to your savings or a contingency fund to further crate a financial cushion for yourself.

How do I make sure the seller pays for this every month?

That is a huge benefit of this program - the seller pays for this subsidy in one lump sum at closing. So you don’t have to go back to the seller to get this monthly payment or worry that the seller might miss a payment. 

This gets collected upfront at the time of closing. The funds are put into an escrow account and disbursed for you. The buy-down is all administered for you behind the scenes so you don’t have to do anything but pay what’s on your mortgage statement.

You need to make sure you’re woking with a lender who can set this up because there’s special documentation that has to be set up and signed at closing to make sure the funds are allocated appropriately.

Why can’t I increase my budget if the sellers are paying to buy my mortgage down?

This buy-down is temporary and will revert back to the original interest rate after the term. So you still have to qualify for the loan today at the 8.25% interest rate. Just because your monthly debt burden will be temporarily lightened due to the lower monthly payments, the lender wants to make sure you qualify at the original terms currently so there aren’t any surprises when the mortgage goes back to the full percentage to be due from you. 

Can you refinance a buydown loan if rates go down?

Yes. If you refinance the loan during the term of the rate buy-down, the seller credits that would’ve gone to the loan will get refunded back to you. So you don’t lose those credits and you aren’t locked into the loan for the entire term. It’s a win-win.

Should you buy down your interest rate?

This isn’t something you would typically do for yourself because you’re not saving yourself any money by doing this on your own. Where this comes in to your advantage is if you can get the seller to pay for this.

And sellers are paying for it!

In my local MLS, there are 740 listings that are offering some sort of rate buy-down. That’s before they’ve even been asked to provide it. Consider the fact that in September 2023 for my local MLS, sellers negotiated an average of 4.4% off the original price of their home to sell. The average sales price on a home was $456,473. The math says sellers are willing to negotiate about $20,000. That’s more than enough for a 2-1 rate buydown on most homes and you’d still have money leftover for some closing costs.

So, here’s a quick recap…

The pros and cons of buying down the interest rate:

Pros:

The seller pays for it upfront.

It’s administered for you so it’s a set it and forget it system.

They can help you pad your savings in the short-term.

Cons:

It doesn’t increase your budget since you still have to qualify at the higher interest rate.

When the buy-down expires, the new payments could come as a surprise.

Not all lenders offer it, so be sure you’re working with a lender who can facilitate a buy-down. We can connect you to one!

Alright. Now you’re an expert on Mortgage Rate Buy-Downs!