Buydown (Mortgage) - Explained
What is a Buydown?
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Table of ContentsWhat is a Buydown of a Mortgage?How Does a Buydown Work?Buydown Structuring3-2-1 Buydown2-1 Buydown
What is a Buydown of a Mortgage?
A buydown refers to a technique used for mortgage financing in which the buyer tries to receive a lesser interest rate for the whole mortgage life. If not the entire life, he/she seeks to receive it at least in the initial stage. For the purpose of reducing the interest rate per month, as well as the monthly payment, the one who sells the property offers payments to the financial institution lending mortgage. In order to balance out the costs associated with the buydown agreement, the builder or the seller generally raises the purchase price of the property.
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How Does a Buydown Work?
Buydown is a subsidy that a home buyer receives on sellers behalf. The person selling the property keeps adding funds to an escrow protection account every month in order to get a subsidized mortgage (for at least the beginning years). This cuts down on the payments made every month, which ultimately makes it easier for home buyers to be eligible for the mortgage.. Be it property sellers or builders, both may provide a buydown option so as to make the property more obtainable for its buyers.
There are different ways and methods to outline buydown terms for mortgage loans. Most of the buydowns function for some years. After the buydown agreement is over, the payments for mortgage rise and are set at market rate. A couple of basic structures for mortgage buydowns include 3-2-1 and 2-1.
For the 3-2-1 mortgage buydown, the purchaser pays less on the mortgage for a period of three years. The amounts for buydown contributed by the seller balance out these payments. For instance, the home buyer who takes a loan of $150,000 for a period of 30 years with a fixed rate of interest of 6.75% will pay less in the first three years. For the first year, they would pay 3.75%; for the second year, the rate of interest would increase to 4.75% and for the third year, it would be 5.75%. After these three years, the standard rate of interest will be 6.75% and for the remaining years, they will be paying the amount of $973 per month. In the first three years, they will be able to save from lower rates of interest. And whatever difference be in those payments would be borne by the property seller. He/she will make this payment to the lending institution in the form of a subsidy.
A 2-1 buydown follows the same approach as 3-2-1, with the only difference being the lower interest rate is available for the first 2 years instead of 3. For instance, if Mr. X borrows $100,000 for a tenure of 30 years, and the fixed rate of interest is 6.75%, he can reduce his mortgage payment for the first 2 years. They would pay 4.75% in the first year, and 5.75% in the second year. And after 2 years, theyll be paying $649 per month at a standard rate of interest of 6.75%. The seller will balance the amount of money saved in the first 2 years by making subsidy payments to the lending institution.