Rate Buydowns

What is a Rate Buydown?

Interest rate buydowns are a way for buyers to reduce their mortgage interest rate by paying a one-time fee to the lender. This fee is typically paid at closing and can be financed as part of the mortgage loan. The goal of an interest rate buydown is to lower the monthly mortgage payment, making the home more affordable for the buyer.  Here in Arizona, I'm seeing this more often in today's Arizona real estate market.  Many purchasers are asking the seller to pay for the rate buy down at closing.  Some sellers are offering this and in other situations it is added to the mortgage (aka monthly payment assistance program).  In either scenario, it is important to understand the home will need to appraise with the added costs.  

Types of Rate Buydowns

There are two main types of interest rate buydowns: a temporary buydown and a permanent buydown.

Temporary

A temporary buydown is typically for the first few years of the loan, and the interest rate will gradually increase over time.

Permanent

A permanent buydown, on the other hand, will keep the interest rate at a lower level for the entire life of the loan.

Buydown Rate or Negotiate Price?

When deciding whether to buy down the interest rate or negotiate a lower purchase price, there are several factors to consider.

• One key factor is the buyer's financial situation. If a buyer has a high credit score and a strong income, they may be able to qualify for a low interest rate on their own, and may not need to pay for a buydown. In this case, it may be more beneficial to negotiate a lower purchase price.
• Another important factor to consider is the current state of the real estate market. In a strong seller's market, where demand for homes is high and there are few properties for sale, it may be more difficult to negotiate a lower purchase price. In this case, an interest rate buydown may be a more viable option for the buyer.
• Finally, the length of time the buyer plans to stay in the home should also be considered. If a buyer plans to stay in the home for a long time, a permanent buydown may be the better option, as it will keep the interest rate low for the entire life of the loan. If the buyer plans to move in a few years, a temporary buydown may be more appropriate.

In summary, whether to buy down the interest rate or negotiate a lower purchase price is a decision that depends on several factors, including the buyer's financial situation, the state of the real estate market and the length of time the buyer plans to stay in the home. Each situation is unique, and buyers should weigh the pros and cons of each option before making a decision. It's good to consult with a financial advisor and a real estate agent to get the best advice and decide on the right path.

Example

As an example, let's consider a $1 million mortgage loan with a 30-year fixed-rate of 5.8%. Without a buydown, the monthly mortgage payment would be $6,503 and the total interest paid over the life of the loan would be $964,842. If a 1-1 buydown is used to lower the interest rate to 4.8% for the first year, the monthly mortgage payment would be $5,878, a savings of $625 per month. However, the total interest paid over the life of the loan would increase to $1,187,828, an additional $222,986.

On the other hand, if a buyer chooses to negotiate a lower purchase price of 1% on the $1 million house, the difference in purchase price will be $10,000 which can be used as down payment or other closing costs. In this case, the monthly mortgage payment and the interest paid over the life of the loan would be calculated based on the original 5.8% interest rate, which would be $6,503 as a monthly payment and $964,842 as the total interest paid over the loan.

The main difference here is that with a higher interest rate, the costs of buying down the rate are more expensive than a lower interest rate scenario, with the tradeoff being that the monthly mortgage payments will be less with a buydown but the overall interest paid over the life of the loan will be higher. Negotiating a lower purchase price is a way to reduce the upfront costs, but it will not have an impact on the long term costs of the loan.

As before, It's important to weigh the short-term and long-term costs and benefits of each option before making a decision and consult with a financial advisor and a real estate agent to understand the implications of each option in your specific situation.

Other Costs to Negotiate

In addition to negotiating the purchase price and buying down the interest rate, there are other ways to negotiate costs in a real estate purchase contract. Some of these include:

HOA Fees: Homeowner's association (HOA) fees can be a significant cost for buyers, especially if they are high or have recently been increased. These fees can be negotiated as part of the purchase contract, and the buyer may be able to negotiate a lower rate or a temporary waiver of the fees.

Golf Memberships: If the property being purchased is located in a community with a golf course, the buyer may be able to negotiate a discounted golf membership or a temporary waiver of the membership fees as part of the purchase contract.

Closing Costs: Closing costs can include a variety of fees, such as lender origination fees, appraisal fees, and title insurance. These costs can be negotiated as part of the purchase contract, and the buyer may be able to have some of these costs waived or reduced.

Repairs: If the home inspection reveals any needed repairs, the buyer may be able to negotiate with the seller to have the repairs completed before closing or to have the cost of the repairs credited back to the buyer at closing.

Credit for updates: Similar to repairs, sometimes there might be certain updates that a buyer would like to make to the property, like a new paint job, new carpet, or new appliances. They can negotiate with the seller to have the credit for these updates as part of the purchase contract.

A Home Warranty: Lastly, a buyer may consider asking the seller to include a home warranty in the purchase contract. This will give the buyer the peace of mind that they will have coverage in case of unexpected repairs or replacements of appliances.

It's worth noting that the type and amount of negotiation that can be done may depend on the the trends happening in the Arizona real estate market, and the specifics of the deal. It's always a good idea to consult with a real estate agent and mortgage broker to understand the specific laws and common practices in the area you're considering to purchase. And, it's also always important to understand the compromises between what's reasonable and what's attainable.