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

Permanent Buydowns:

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.

About these examples: The numbers below are a hypothetical illustration of how buydown math works, not current rates or an offer of credit. They assume a $625,000 purchase with a 20% down payment ($125,000) and a $500,000 30-year fixed-rate loan repaid in 360 monthly payments. Payments shown are principal and interest only; property taxes, homeowners insurance and any HOA dues would make the actual payment higher. APRs assume no lender fees other than the discount points shown. Your actual rate, APR and payment depend on your credit, the property and the market on the day you lock.

Example: $500,000 Loan amount

With a $500,000 loan amount and if you buy down the interest rate from 6.625% (6.625% APR, no points), with a principal and interest payment of $3,201.55, to 6.375% (about 6.471% APR with 1 point), with a principal and interest 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 about 61 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. Many loans are paid off or refinanced within 6–7 years, so with a 5-year recoup period you could lose this upfront money if you sell or refinance within those 5 years.

What would I do?

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.

Temporary Buydowns:

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.

Example: $500,000 Loan amount

With a $500,000 loan amount and an interest rate of 7% (7.000% APR, assuming no lender fees; who pays the buydown cost can change the APR, which your Loan Estimate will show), if you choose a 2-1 buydown, the principal and interest payment of $3,326.51 would be reduced to $2,684.11 for payments 1–12 and to $2,997.75 for payments 13–24, then return to $3,326.51 for payments 25–360. The cost of that buydown would be about $11,654, the total of the monthly differences over 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.

So which product is best for me?

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 seem less expensive than 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.

Related reading: when a refinance makes sense, fixed-rate loans and buying a home in Durango. Ready to compare your options? Call or text me at 970-828-1610, or see how I compare with other mortgage lenders in Durango CO.