Well, this term is understandably confusing, because in actuality, most mortgage buydowns don’t result in permanent and long-lasting lower monthly payment these days butonly temporary ones.
MORTGAGE BUYDOWNS AREN’T THE SAME AS OPTION ARM LOANS WITH NEGATIVE AMORTIZATION
For a large number of borrowers, a mortgage buydown might be more attractive than other types of loan options, such as an adjustable rate mortgage – or ARM, as it is popularly known – that includes a negative amortization feature. That’s what’s known as an Option ARM loan .
The mortgage buydown program could be more advantageous because your mortgage payment would always include payments to both principal and interest. That means that monies will always be directed to pay down your mortgage balance and not merely the interest alone.
HOW TODAY’S POPULAR MORTGAGE BUYDOWNS WORK
To get the gist of how popular mortgage buydowns work these days, consider these factors:
Your payments are reduced and calculated based on a lower rate overall. The seller or the buyer is the one who pays the difference between the actual note rate and the lowered interest rate in cash.
Look at mortgage buydowns like subsidies. They are akin to saving $1,200 in your bank account and then withdrawing $100 each month for 12 months in order to assist you in making your mortgage payment.
EXPLAINING THE 3-2-1 MORTGAGE BUYDOWN
The so-dubbed “3-2-1 Mortgage Buydown” is a 30-year fully amortized mortgage whereby the interest rate goes up by 1% each year for the first three years – and for the remaining 27 years of the loan term, the interest rate is fixed.
It would probably help to look at an example:
If you have a loan balance of $350,000 with a fixed interest rate of 6.75% for 30 years, either you or the seller could choose to buy down the interest rate by paying one big lump sum of $15,853.
Consider these factors:
#1 – Your first-year interest rate would be 3.75%, which equals $1,621 per month in mortgage payments.
#2 – As for the second year, your interest rate would increase by 1% to 4.75%, which means you’d pay $1,826 each month.
#3 – When the third year rolls around, your interest rate would jump another point to 5.75%, which means your monthly payments would increase to $2,043.
#4 –Since the first three years have elapsed, for years 4 through 30, the interest rate would increase to and remain at 6.75% for the life of the loan, which means $2,270 per month payments would be the order of the day.
DETERMINING YOUR BUYDOWN AMOUNT
Based on the above calculations, the amount you save in your first year (instead ofpaying $2,270 per month) is $649 per month, or $7,790 for the whole year.
Additionally, your savings in the second year (instead of monthly $2,270 payments) would be $444 per month or $6,332 for that whole year.
The third-year savings (instead of $2,270 per month) would be $228 each month,
or $2,731 for that entire third year.
Taking the time to add up all those yearly savings ($7,790 + $6,332 + $2,731) means you’d come up with a sum of $15,853 – and that’s why it would cost you ($15,853) to “buy down” the first three full years of interest rate and payments.
WHAT’S SO GREAT ABOUT A 3-2-1 MORTGAGE BUYDOWN?
The best thing about getting a 3-2-1 mortgage buydown is that the person taking out this type of loan can qualify for it at lower interest rates and payment amounts, for example, a 3.75% interest rate and payment amount of $1,670 – instead of needing to try and quality at the higher 6.75% rate and payment amounts such as the higher $2,270 monthly payment in the example above.
Therefore, instead of experiencing a huge payment jump right away, it increases incrementally – about $200 annually, for the first three years of the loan. This is a big benefit for homebuyers whose salaries might be lower in the initial 36 months of the loan, but expect their income to increase later to help make the higher payments at hand.
HOW A 2-1 BUYDOWN MORTGAGE WORKS
The “2-1 Buydown Mortgage” is also a 30-year fully amortized mortgage with an interest rate that increases 1% each year – but only for the first two years. For the remaining 28 years of the life of the loan, the interest rate becomes fixed.
To see it in action, let’s consider an example:
If you have a loan balance of $350,000 with a fixed interest rate of 6.75% for 30 years, either you or the seller could “buy down” your interest rate with the payment of a lump sum of $8,063.
Similar to the other example, first we’d have to figure out the monthly payment amounts:
#1 – In year number one, the interest rate of 4.75% would create a $1,826 monthly payment.
#2 – In year number two, the interest rate of 5.75% wouldmean you’d pay $2,043 per month in payments that year.
#3 – Finally, for the 3rd through 30th years, the interest rate would be fixed at 6.75%, meaning $2,270 monthly payments for those 28 years.
Therefore, the amount saved in the first year (in relation to the $2,270 per month payment) would be $444 per month or $6,332 annually.
In the second year, the savings (in comparison to the $2,270 monthly payment) would $228 per month or $2,731 for that whole second year.
Summing up the two annual savings amounts for the first two years ($6,332 + $2,731) equals a grand total of $8,063. In the end, it would cost you $8,063 to buy down both the interest rate and payments for those first two full years.
Lenders generally require a down payment of 10% in order to obtain a 3-2-1 Buydown and a 5% down payment for the 2-1 Buydown mortgage option.This article was written by American Home Mortgage Servicing Inc .