What is a mortgage “buy down”?

With rising mortgage interest rates, “buy-downs” are the new buzz word. A “buy down” either temporarily or permanently reduces the interest rate on a mortgage loan. With the local real estate market cooling down, it’s not unusual to see a Seller agree to actually pay for a buy-down to help sweeten the deal for a potential home buyer. It can actually be a “win-win” for both buyer and seller as the buyer receives a lower mortgage payment and the contribution paid by the seller may be less than what a price reduction might be.

As I mentioned, there are two basic types of buy downs. In this post, we’ll discuss the “permanent” buy down.  A seller can contribute a certain percentage of the sales price to go towards discount points to permanently buy down the interest rate. The amount a seller can contribute varies depending on how much down payment a buyer has towards the home and the mortgage program they are using for their financing. Most programs will allow a 3 percent contribution from the seller which in most cases, will dramatically reduce the buyer’s mortgage interest rate and therefore their mortgage payment.  For the seller a 3 percent contribution towards points will cost them a lot less than a 5-10% reduction to the sales price.

For example, let’s take a home listed at $700,000 in the greater Seattle area. Betty Bellevue and her beau who both have credit scores of 740 would like to purchase the home a with 10% down payment using a 30 year fixed conventional mortgage.

EDITORS NOTE: The mortgage rates quoted below are EXPIRED. If I can provide you with current mortgage rates for your personal scenario on homes located anywhere in Washington state, click here.

Assuming they make a simple full price offer, it could look like this:

  • OPTION 1:
  • Sales price: $700,000
  • Loan amount: $630,000
  • Interest rate: 5.125% priced with 0.007 points (APR 5.362%)
  • Estimated mortgage payment: $4246.35 (includes principal, interest, private mortgage insurance, estimated property taxes and estimated home owners insurance)
  • Funds for closing: $80,640.96 (includes 10% down payment, closing cost, property tax/insurance reserves and 15 days of prepaid interest*).

Or… perhaps the seller is considering reducing their price or Betty and Beau are going to offer 5% less than the original list price.  

  • OPTION 2:
  • Sales price: $665,000
  • Loan amount: $598,500
  • Interest rate: 5.125% priced with 0.007 points (APR 5.364%)
  • Estimated mortgage payment: $4037.53 (includes principal, interest, private mortgage insurance, estimated property taxes and estimated home owners insurance)
  • Funds for closing: $76,860.46 (includes 10% down payment, closing cost, property tax/insurance reserves and 15 days of prepaid interest*).
  • SELLER NETS $35,000 LESS than full price offer above.
  • BUYER REDUCES MONTHLY MORTGAGE PAYMENT BY $208.82 AND REDUCES FUNDS FOR CLOSING BY $3780.50.

Here’s where things get interesting….

Here’s what it would look like if Betty and Beau Bellevue have a full price offer with a 3% seller contribution which they use a majority to buy down the interest rate with any remainder going towards closing cost.

  • OPTION 3:
  • Sales price: $700,000
  • Loan amount: $630,000
  • Interest rate: 4.500% priced with 2.878 points (APR 4.977%)
  • 3% Seller Contribution: $21,000
  • Estimated mortgage payment: $4008.20 (includes principal, interest, private mortgage insurance, estimated property taxes and estimated home owners insurance)
  • Funds for closing: $77,566.45 (includes 10% down payment, closing cost, property tax/insurance reserves and 15 days of prepaid interest*).
  • SELLER NETS $14,000 more than the 5% price reduction (aka option 2)
  • BUYER REDUCES MONTHLY MORTGAGE PAYMENT BY $28.33 FROM OPTION 2 (REDUCED PRICE). FUNDS FOR CLOSING ARE HIGHER BY $705.99 compared to option 2.

And my personal favorite option for Betty and Beau based on their scenario is the same as “option 3” and instead of using the 3% seller contribution completely towards buying down the rate, they use a portion of it to pay for the private mortgage insurance. With this scenario the private mortgage insurance is paid for “upfront” instead of being included in the monthly mortgage payment.  The mortgage rate is still lower and the payment is lower than option 3 without mortgage insurance.

  • OPTION 4:
  • Sales price: $700,000
  • Loan amount: $630,000
  • Interest rate: 4.625% priced with 2.212 points (APR 4.971%)
  • 3% Seller Contribution: $21,000
  • Estimated mortgage payment: $3,892.41 (includes principal, interest, estimated property taxes and estimated home owners insurance)
  • Funds for closing: $80,081.01 (includes 10% down payment, closing cost, property tax/insurance reserves and 15 days of prepaid interest*).
  • SELLER NETS $14,000 more than the 5% price reduction (aka option 2)
  • BUYER REDUCES MONTHLY MORTGAGE PAYMENT BY $145.12 FROM OPTION 2 (REDUCED PRICE). FUNDS FOR CLOSING are about the same as option one (original full price offer) coming in slightly lower by $640.96.

Rates quoted are as of 5:00 pm PST on October 25, 2018 and are subject to change as well as credit approval. NOTE: If I can provide you with current mortgage rates on homes located in Washington state, please click here.

*The APR and closing cost quoted above include 15 days of prorated interest. Prorated interest is based on the date of closing. Closing towards the end of the month will reduce the amount of interest and closing earlier in the month will increase the amount of interest due.

My point is that with using a buy down, it’s possible to meet the seller half-way and potentially create a financial better scenario for the home buyer.

If the seller agrees to provide you with a contribution towards buying down your interest rate or closing cost, it must be included in the purchase and sales agreement. I also strongly recommend that you consult your mortgage professional to confirm how much the seller can contribute with your personal scenario.

If you are considering buying a home (or refinancing) located anywhere in Washington state, I am happy to help you!  I have been helping people with their mortgage needs since April 2000 (and was in the title and escrow industry for 14 years prior to my mortgage career). 🙂

PS: Stay tuned for a follow up post on 2-1 buy downs.

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