Seller-Paid Mortgage-Rate Buydowns

Interest rates for home loans have increased rapidly over the past months and now is the time to explore your options as a homebuyer. which wasn’t even remotely on the table for homebuyers in the previous years. Now homebuyers may be able to achieve a more attractive rate with a simple home seller concession: mortgage interest rate buydowns. 

A seller-paid mortgage interest rate buydown will typically give a buyer higher cost savings than if the buyer negotiated a lower purchase price. It may also save the seller money to pay for discount points rather than reducing the home price.

Buyers asked and received a surprising amount of seller concessions – like as mortgage interest rate buydowns – during the 4th quarter of 2022. Mortgage rate buydowns are a wonderful advantage for buyers but all homebuyers should understand there are some risks involved. Below we will explore seller mortgage interest rate buydowns to allow you to determine if this is right for your next purchase offer.

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How Do Mortgage Interest Rate Buydowns Work when Paid by the Seller

When a seller offers to pay funds at escrow to buydown a buyer’s mortgage interest rate, it can be for the duration of the entire mortgage loan or for the first portion of the loan. The seller can either pay towards the buyer’s closing payment (closing costs) to reduce the amount of money the buyer needs to bring to the table at closing or the seller can pay for a rate buydown temporarily.

Option 1: Closing Cost Concessions from the Seller

If the seller is going to provide a rate buydown for the entire term of the mortgage, the seller will cover the buyer’s closing costs to allow the buyer to pay down their mortgage rate. This is also called buying mortgage discount points. While it can vary from lender to lender, one point lowers the mortgage rate by about 0.25 percent point. One point is equivalent to 1% of the loan amount. So if you buy a $1,000,000 home with a down payment of 20%, your loan amount would be $800,000, and one point costs $8,000.

So is this the right option for you? It is important to consider your current situation and financial goals. If you plan to sell before 30 years, make extra principal payments over the loan term, or refinance in the coming years, this may not be the best option. It is important to compare this to the next option to see what saves you the most money long term. Another factor to consider is what type of loan you are using. FHA lans, US Agriculture loans and VA loans all have limits on the amount the seller may contribute to a buyer’s closing costs. Message us to find out more about your different options and we can help you determine what loan option is right for you when considering a seller rate buydown.

Option 2: Temporary Rate Buydown Paid by the Seller

A temporary mortgage rate buydown by the seller is gaining popularity. In this situation, the buyer’s rate for the first couple of years of the loan is lowered. This allows the buyer to save money in interest in the first couple of years of the loan because the seller essentially prepaid the interest rate costs in those years. There are few ways a seller can do this:

1-0 Buydown

In this scenario, the rate and monthly mortgage payments are reduced for year one of the loan, increasing to the note/terminal rate for the remainder of the mortgage loan. 

2-1 Buydown

In this scenario, the rate and monthly mortgage payments are reduced for year one and two. The first year is the lowest rate, the second year rate rises but remains below the note/terminal rate, and then increases to the note/terminal rate for the remainder of the mortgage loan (year 3-30).

3-2-1 Buydown

This is similar to the 2-1 buydown but the rate remains lower than the note/terminal rate in the third year a well before increasing to the note/terminal rate for the remainder of the loan term (year 4-30).

The options for the temporary rate buydown could be a better option for buyers who plan to sell or refinance in the next five years or less. If you are buying your forever home or plan to stay in the home for 10 plus years, then the next option could be a better option to consider. It also depends on how much negotiation room you have as a buyer in terms of how much the seller is willing to contribute to a buydown. A very important buyer consideration is the affordability of the note/terminal rate mortgage payment. While the first 1-3 years will save you money, you need to be sure you can afford the payment once the mortgage adjusts to the note/terminal rate after the buydown timeframe expires.

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The Benefit of Seller-Paid Rate Buydowns

It may come as a surprise but rate buydowns can also be beneficial to the seller just as it is for the buyer. The seller can actually save money by buying down the mortgage rate instead of reducing the purchase price. It can be a win-win. Seller gets a higher purchase price and the buyer saves money on their monthly mortgage payments.

The chart below from usnews.com shows a great example of this win-win situation.

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Beware of the Risks Involved

Like everything, seller mortgage-rate buydowns can have some risks. Depending on the home and situation, seller concessions can be better applied toward things like closing costs or home improvements. If considering a temporary buydown, the buyer could be in a less than idea situation given the volatile state of mortgage rates and the economy.

However, keep in mind, you can refinance into a 30 year fixed loan at any point if the rates drop. Bottom line, everyone’s situation is different and the best recommendation is to work with your real estate and loan professional to determine what option is best for you.

Many people have decided to wait until mortgage rates decrease to buy a home, but there is also an inherent risk in doing so – what if prices do continue to rise? San Diego County has been an undervalued market for decades compared to San Francisco and Los Angeles Counties. As more and more businesses decide to move to San Diego, we will see an increase in appreciation in housing. It isn’t always best attempt to time the real estate market with such volatility in the interest rates and real estate market. 

There are also other considerations when saving money with seller concessions that are now available to buyers – from lower the purchase price to asking for credits toward home repairs.

If you are not sure if a mortgage rate buydown is right for you, please reach out to us at 858-775-9895, and we are happy to have a conversation to help you make the best decision for your situation.

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Source: US News