How do you get a lower mortgage rate when buying a home?

Answers:

1. Wait for the market to change and for rates to move down.

Who can predict that? I would say, in this environment, that’s a little risky.

2. Lock a rate and pay points.

Known as a permanent rate buydown. Crunch the numbers and work out a break even based on how long you plan to hold or stay in the home.

3. Do a temporary buydown.

Huh, temporary buydown? What’s that?

Glad you asked.

The new mortgage product push in the industry is called a “temporary rate buydown.” The truth is that it’s really not a new product; it has been around for a long time, but market conditions in the last couple of years negated the need for a temporary rate buydown as an option.

The resurgence of the temporary buydown is due to the increase in interest rates and a much-needed strategy by the mortgage industry to drum up more business for themselves and their partner real estate agents. Basically, you can start off with a rate of up to 3% below the real market rate. Wow! What’s the catch?

A 3-2-1 interest rate buydown requires an up-front lump sum escrow payment that is calculated by taking the difference between the real market rate payment and the reduced rate payment (up to 3% reduction of market rate) for the first 3 years, and that difference is put into an escrow account. The “deal making” concept when negotiating is to ask a seller to pay the escrow amount to move the deal along.

For example, in a 3-2-1 buydown, with a market note rate of 7.25%, the rate for the first year would be 4.25%. See the chart below.

Example: 3-2-1 temporary buydown with

30-year fixed Mortgage Loan amount $500,000

Actual Note rate 7.25%

In a 3-2-1 buydown the interest rate is 3% lower than the note rate in year one, 2% lower than the note rate in year two, and 1% lower than the note rate in year three. (In a 2-1 buydown the interest rate is 2% lower than the note rate in the first year and 1% lower than the note rate in the second year. In a 1 buydown the rate is reduced by 1% in the first year.)

Total Buydown Cost $23,196 (*$951 +*$650 + *$332 = $1,933 x 12 mos. = $23,196 put into escrow.)

In this example, the escrow amount of $23,196, if you take a 3-2-1 buydown, can be contributed by an amenable seller. Available on Fixed Rate and Adjustable-Rate Mortgages (ARMs). There is a dramatic savings in payment. Beware that your timeline is 3 years before your payment pops up, so your strategy should be short term—in either staying or betting that rates come down. What happens to the escrow amount if you pay off the loan early? The escrow amount is applied to the principal balance outstanding.

Question: Why not take a permanent buydown option (see answer #2 above) and ask the seller to contribute to the points for the lower rate? After all, the seller can contribute between 6-9% of the mortgage amount as a seller’s concession.

Obviously, permanent sounds better than temporary, especially if someone else pays to buy down the mortgage rate, BUT…. if you look at the rates below, the same exact rates as the ones used in the earlier temporary buydown chart, you’ll see that getting that permanence is quite expensive on the 4.25 rate compared to the 3-2-1 buydown option. The costs get closer when you look at a 2-1 and 1 buydown, and therefore a permanent buydown may be better for all involved at the higher rates.

Example: Permanent Buydown of 7.25 mortgage rate /

30-year fixed Mortgage Loan amount $500,000

Remember, calculations must be made using current market rate data, and never assume that “sexy marketing” saves you money.

Carl E. Guzman, CPA, is the president and founder of Greenback Capital Mortgage Corp., a mortgage broker/banker in New York, New Jersey, and Florida, celebrating over 32 years of helping borrowers with their financing needs. He is the creator of www.mortgagegenius.com, a mortgage financial advisor, a CPA by training and a licensed real estate broker in New York and New Jersey specializing in complex residential and commercial mortgage solutions.