Buydowns have been a recent topic of conversation among local Realtors and home buyers alike. So in an effort to help answer lots of questions here is a breakdown of the two types of buydowns: Permanent & Temporary
A Permanent buydown is where you pay a fee today to have a lower interest rate for the life of your loan. Historically the interest rate is reduced by ¼ percent with a 1% upfront fee. Sometimes the amount of Interest rate buydown can vary depending on the current interest rate yield curve. But assuming ¼ buydown is the current scenario it’s a simple math problem to see if it makes sense to buydown your interest rate permanently.
With a $500,000 loan amount and if you buydown the interest rate from 6.625%, with a P&I Payment of $3,201.55, to 6.375%, with a P&I Payment of $3,119.35, you would save $82.20 monthly. So it would cost you the 1%, or $5,000, to save $82.20 monthly which would take 60.1 months, or just over 5 years to recoup.
So, the question becomes will you still be in the home after 5 years? Is there a chance you will have an opportunity to refinance within the next 5 years? Permanent buydowns are interesting because they are really only valuable if you’re in the home for longer than the recoup period. With the average life of a loan is 6-7 years and a 5 year re-coup period odds are you may loose this upfront money if you sell or refinance within the 5 years.
I would rather keep my 5,000 dollars and just take the “Organic” interest rate without paying any points to buy it down and look for an opportunity to refinance if rates come down.
A Temporary buydown comes in the form of a 3-2-1, a 2-1, or just a 1-year buydown. Basically, the first number represents the reduction in payment as though the interest rate was reduced by that number for the first year, the second number represents the reduction in payment as though the interest was reduced by that number for the second year, and so on.
With a $500,000 loan amount and an interest rate of 7% and you choose a 2-1 buydown then the actual monthly payment of $3,326.51, would be reduced to $2,684.11 for the first year, and to $2,997.75 for the second year and then back to the $3,326.51 for the remainder of the term of your loan. The cost of that buydown would be $11,653.92 OR equal to total of the monthly difference of your buydown amount vs. your actual monthly payment for the 2 years.
Temporary buydowns are just a vehicle for you to pay an upfront amount at closing and have the lender hold that amount and apply the difference on the payments for the first two years until the buydown period is over.
The rationale for getting a temporary buydown is usually based on interest rates being high and the hopes that interest rates will soon be lower and you can refinance into a lower interest rate loan and have a reduced payment. If that is your situation then you should seriously question if you can afford the payment in the event interest rates don’t go down. If they don’t, you could be in a pretty tough financial situation.
Another line of thinking is that maybe you have an auto loan that will be paid in full in 2 years and once that is done you can afford the full monthly payment.
There are many reasons to consider each of these products and it always boils down to a math problem. Just make sure you consider all the numbers before committing to one of these options. Remember they are just products and fancy ways to make a loan seam less expensive then they are. In my opinion the best way to move forward is to not buy into these fancy products, take the current “Organic” interest rate (Basically the rate with no points), and then look for an opportunity to refinance if one presents itself.
I hope that helps with your decision-making on your next purchase. Thank you.
The Fed’s campaign of interest rate hikes spanned over 18 months, representing a significant intervention in the central bank’s history. These measures have transitioned the Fed into a phase of observation, as it awaits indications of declining inflation rates towards its 2% target, as measured by the Personal Consumption Expenditure (PCE) index, a preferred inflation gauge.
When should I refinance?
So that’s my goal here – to shed some light on what the Federal Reserve is and how it impacts your finances and investments.