Uncategorized February 28, 2024

2-1 and 3-2-1 Temporary Buy Downs

What is a 2/1 Buy Down?

It’s a temporary reduction of the Buyer’s mortgage payment by the equivalent of two full interest rate points the first year and one full point the second year.  It accomplishes this temporary “rate adjustment” by essentially pre-paying the difference in interest between the buyer’s actual approved rate and the temporarily adjusted rate.  The result is that the Buyer’s monthly mortgage payment looks and feels much more affordable for the first year (like a loan at 4.75% vs. 6.75%, for example) and moderately more affordable the second year (like a loan at 5.75% vs. 6.75%). The idea is that the Buyer can then refinance the loan when rates improve (which most experts predict WILL happen within the next year or two) or be in a better position to afford the higher payment in a couple of years’ time.  This strategy allows Buyers to take advantage of today’s home prices at tomorrow’s more attractive interest rates.  What’s more, certain lenders, like Penrith Mortgage, are offering to waive their portion of future refinance fees, making the cost to do so much more affordable and making this temporary buy-down strategy practically a no-brainer.   While most people expect interest rates to come down, no one expects home prices to go down anytime soon.  In fact, prices are already on their way back up. When interest rates improve, most people expect prices to increase even more.

One of the best features of a temporary buy down is that the credit allotted toward the buy-down belongs to the Buyer, no matter what happens. Let’s say, for example, that the Buyer decides to refinance the home in a year, rather than in two years.  The amount of money remaining in the buy-down account (e.g. the full second year of pre-paid interest) would get credited back to the Buyer at the time of re-finance.  Same thing if the Buyer decides to sell rather than re-finance.  The credit is never lost, regardless of what the Buyer might do in the future.

There are also 3-2-1 buy downs available. Same principle, but the first year the savings would be the equivalent of 3 interest rate points, the second year 2 points and the third year 1 point.

Is a 2/1 or a 3/2/1 Buy Down better than a Straight Price Reduction?

It depends on the Buyer’s goals and needs. With a straight price reduction, the monthly savings will likely be negligible. That is because when you adjust the purchase price by a certain amount (say $10,000) you are adjusting the loan amount by even less and the difference in interest and thus monthly payment is minimal (in the example of a $10k price adjustment, the difference in monthly payment would be about $50 – $65 a month depending on the interest rate and what percentage of the purchase price is being borrowed).  Where you would really see the benefit of that $10,000 price reduction is when it came time to sell because you’d have a smaller loan to pay off.

With the same credit applied to a 2/1 buy down, the savings are more front loaded.  You would have a larger loan to pay off when it came time to sell, but you would save hundreds every month initially.  That savings, if not used to live on, could be saved or invested.  A 2/1 buy down would be beneficial to someone for whom the monthly payment, while feasible, might yet be tight.  The initial monthly savings would offer cushion and prevent them from having to possibly borrow for other costs.  Or the savvy investor who either plans on refinancing (at little or no cost, if working with a lender like Penrith) or selling in a couple of years, would take the upfront savings and invest it elsewhere.

How does this differ from a permanent rate buy down?

A 2-1 or 3-2-1 temporary rate buy down offers significant monthly savings, but only over a short (2 or 3 year) period of time.  A permanent rate buy down offers more modest monthly savings but for the life of the loan.  The cost of a permanent discount is significantly higher per percentage point than a temporary buy down.  So, where a $10,000 credit might buy you a 2% or greater reduction in interest rate for the first year of a temporary buy down, that same $10,000 credit might only buy you only a fraction of a percentage point on a permanent rate adjustment.  The cost of rate adjustments varies depending on current mortgage market conditions.  The longer you plan on staying in a home (or in a mortgage), the more sense a permanent rate buy-down will make. But, the monthly savings will take years and years to pay off the cost of the rate adjustment, so it’s got to be a pretty long term plan to make any sense.  Additionally, if your plans change and you need or want to sell or refinance sooner than anticipated, the money spent on the permanent rate buy down is wasted.