Ah, you can feel the tension between buyer and seller mounting.
In the one corner, you have the wary buyer ready to pounce on a house she loves, except she’s troubled by a nagging little voice in her head, telling her not to overpay. She’s well aware of the National Association of Realtors’ July 28 report showing pending sales of existing homes (contracts signed but sales not closed) slipping 1.1 percent in June. Worse, the number was off 7.3 percent from a year ago. The last thing she wants is to buy at the top of the market.
In the other corner, you have the seller who finally decided to put up his “For Sale” sign, after watching the value of his home claw back to its pre-Great Recession level. For 2013, home prices rose 11.3 percent nationally, following a 7.3% gain in 2012, according to the S&P/Case-Shiller Index. So, he’s guardedly optimistic that it’s a good time to sell and move on with his life.
So, why is the buyer offering $50,000 less than his asking price? Should the seller feel insulted and walk away — after all, he’s thinking one negative housing report hardly constitutes a trend?
What is a permanent buydown mortgage?
To keep buyers and sellers talking and, more important, signing, more real estate agents and their go-to lenders are resorting to a sales and marketing ploys long favored by home builders eager to give shoppers of their homes that extra bit of financial assistance to close the deal. It’s called “seller-assisted below-market-rate financing,” better known as the “buydown” or “buying down the loan.”
“It gives sellers one more tool with which to reel in buyers,” said Norma Morales, a Wells Fargo lender based in Southern California. “We saw a lot of buydowns in 2011, and we could see them again in certain pockets if sellers start meeting buyer resistance.”
Before you decide whether a permanent buydownn mortgage is right for you, see what mortgage rates are going for in your area.
How the builder buydown works
Builders and developers, who are, after all, sellers, often use the buydown to incentivize and induce buyers to pull the trigger on a new-home purchase. They offer what is known as a 3-2-1 buy-down, meaning they will reduce your monthly payment, typically on a 30-year-fixed-rate mortgage (principal and interest) by 3 percentage points below market rate the first year of your loan, 2 percentage points the second year of your loan and 1 percentage point the third year of your loan. From the fourth year forward, you will pay your true, unassisted rate.
So, in a 3-2-1, if you took out a $100,000 loan at 7 percent, the builder would knock down your first-year start rate to 4 percent for a monthly payment of $477. The second year, your rate would rise to 5 percent ($564) and the third year, it would climb to 6 percent ($600). In years 4-30, your monthly payment would be $665.
At 5 percent, your $100,000 loan would result in monthly $536 payments, but with the 3-2-1 buydown, your monthly payments would be $370 the first year, $422 the second year, and $477 the third or final year of your buydown.
While the borrower’s payments are reduced in the early years in the 3-2-1 buydown, the payments received by the lender are the same as they would have been without the buydown. The shortfalls from the borrower are offset by withdrawals from an escrow account that the builder has funded.
Why a seller would use a permanent buydown mortgage
From our above builder buydown example, the home seller, who received an offer $50,000 below his asking price might use a buydown to receive a more attractive offer.
Rather than offer the buyer a temporary buydown, as in the 3-2-1 example above, the agent or lender proposes that the seller offer a permanent buydown of the buyer’s mortgage loan. By agreeing to pay a certain amount of money upfront to the buyer’s lender, the seller can reduce the buyer’s monthly payment to a more manageable monthly level — to a level that would, in effect, raise the buyer’s offer to a point where it might be more acceptable to the seller.
As so often happens, whether it’s a real estate or some other transaction, the question boils down to, how much?
Yes, it might seem strange that the seller has to put out a certain amount of upfront money to keep the deal together, but let’s see how the math plays out:
Sellers make their points
For buydowns, lenders use discount points. One discount point equals 1 percent of the loan, so in our case, 1 percent of $100,000 is $1,000.
Typically, one discount point shaves 1/8th of 1 percent off the interest rate. So, two discount points would shave a 1/4th of 1 percent off the interest rate. To shave a full percentage point off a loan, say, from 5 percent in our example to 4 percent, would require 8 discount points or $8,000. To shave two full percentage points would cost $16,000.
For the buyer, the difference between paying 5 percent and 4 percent over 30 years would result in savings of $21,384. The difference between paying 5 percent and 3 percent over 30 years would result in savings of $41,479.
So, if the seller agrees to kick in $16,000, the buyer should be able to bring up her offer more than $40,000. The point is, resorting to a buydown strategy can bring two parties supposedly far apart closer together or at least within shouting (negotiating) range.
Permanent buydown mortgage strategies usually gain in popularity in higher-interest-rate environments, but there’s no law that says the same tactics can’t also be applied in slower-moving real estate markets.
Whether the real estate market is starting to cool is almost beside the point — one month doesn’t make a trend, and every zip code is different in terms of activity — but if you’re thinking of selling, it doesn’t hurt to have a proven stimulus tool up your sleeve to spur sales.