Interest Rate Buydowns What Is Old Is New Again

Whenever you hear about buydown loans again, it?s a sure sign interest rates have risen and the real estate market has slowed down.

A buydown occurs when the interest rate is ?bought down?, that is, with cash to pay for a lower interest rate known as a permanent buydown or ?borrowed? into the future with a higher base interest rate as in a temporary buydown. The lower interest rate, the lower the monthly payment and loan qualifying is easier. Conversely, the lower the interest rate the more it costs.

The permanent buydown buys the rate down for the life of the loan. Typically it costs one point or one percent of the loan amount to buy it down a quarter of a percent in rate. If the current rate is 6.50% for example, you can buy it down to 6.25% for about one point.

A temporary buydown is for a short, set period of time. A 2-1 buydown is most common where the initial interest rate is two percent below the base note rate for the first year and then 1 percent below the base for the second year, finalizing at the base note rate for the remainder of the term. An example would be a base note rate of 7.50% with the first year at 5.50%, the second at 6.50% ending with 7.50% for the remaining 28 years on a 30 year loan.

It can be bought down with cash and/or a higher base interest rate with revenue called a Yield Spread Premium, also known as YSP, rebate or premium pricing. Think of it as leveraging tomorrow?s higher interest rate to gain a lower one today.

Why is this important to you as a seller? It increases your pool of qualified buyers for your home. It costs you between one to three points but it is part of dealing with a slow market; either lower the price of your home or give more incentives. It is a widely used tactic by new home builders when the market softens.

Why is this important to you as a buyer? The buydown subsidizes your monthly payments to allow time for your income to catch up to the yearly increase of approximately 7.5% above the previous year?s payment. You can buy the home you want today rather than wait, or worse, buy a lesser home you really didn?t want. You get the added fixed rate security benefit knowing exactly what your monthly payment is at any time, unlike an adjustable rate mortgage. Structured correctly, you benefit at the seller?s expense.

Why is a permanent buydown not a good option on a purchase? One main purpose of the buydown is to get more people to qualify for more home. Three point cost only drops the interest rate about ? of one percent, the permanent rate of 6.50% lowers down to 5.75% for example. A temporary buydown using the same scenario would lower the first year?s interest down to 4.50% percent, a full two percent below. It also lowers the monthly payment substantially below the ? of one percent rate drop.

There are different buydown variations to discuss with your mortgage consultant if you are a buyer or a seller. The 3-2-1 buydown works on the same premise of the 2-1 only over a three year period. A ?flex-fixed? buydown has incremental increases every six months. Structuring depends on your credit score and how much you are putting down.

If you are a seller, a seasoned mortgage consultant will structure the buydown so it doesn?t cost you as much yet broadens the market appeal of your home. It becomes a powerful marketing tool for your real estate agent to sell your home sold faster. This mortgage consultant will also structure the purchase of your new home based on your projected net proceeds to make both transactions smooth and tailored to fit you.

For you the buyer, a buydown is a valuable financing option added to your mortgage arsenal. The buydown and the cost need to be structured into your formal offer to purchase contract. It broadens the number of homes you qualify for and if structured correctly, you benefit from a lower initial monthly payment and interest rate, at the seller?s expense. By the time the interest rate hits the higher base rate; you will be in a position of handling the higher monthly payment with your increased future income if the rates remain high and/or to refinance if rates drop.

Your mortgage consultant will explain the program, the payments and cost in detail in terms you can understand; what it means to you today and over time. Insist on a side-by-side mortgage analysis in writing from mortgage software such as The Mortgage Coach, LoanMagic or a similar mortgage analytical product. If they can?t, you need to find another lender.

Vic Yamauchi, a San Diego native, started his real estate career in 1978 as a Regional Real Estate Manager for Pier 1 Imports after graduating from San Diego State University.

A Realtor in 1980, he learned the business the hard way as home interest rates climbed to over 19% and became well versed in creative financing that has served him to this day. He listed up to 25 homes in one month. He is celebrating his 28th year overall in the real estate and mortgage industry.

Vic has been an owner or co-owner of four different mortgage companies since that time. He was SVP of Retail Production, AME Financial and a past Branch Manager for Norwest/Wells Fargo Home Mortgage.

Currently, Vic is a senior mortgage consultant with CalPacific Mortgage Consultants, http://www.capmc.com, and President of Homebuyers Resource Center, http://www.mlsrec.com.