Temporary Buydowns

This is going to be a long one, but it’s pretty important if you are planning on selling a house!  

We have seen mortgage rates move up considerably over the past few weeks, and once again buyers are asking the same question:
What can we do to make the payment more affordable?
One option that has quickly moved back to the forefront is the TEMPORARY BUYDOWN. 

We have all heard the phrase – "Date the rate and marry the house." That sounds great, but there is one small problem. Can the buyer afford to get married?

That is where a temporary buydown can become a very powerful tool.
WHY ARE WE TALKING ABOUT BUYDOWNS AGAIN?
For the examples below, we will assume a 30-year fixed mortgage at 7.50% with no points. Rates can obviously change daily. They could be 7.00% tomorrow or 8.00% tomorrow. FHA and VA rates are also frequently lower than conventional rates, while credit score, down payment, property type, occupancy and loan size can all affect pricing. But 7.50% gives us a good round number to explain how these programs work. We have not dealt with mortgage rates at these levels very often in recent decades. We saw similar rate levels during 2023, and before the current cycle you have to go back many years to see sustained rates in this neighborhood. So, buyers are having to adjust their mindset.

THE INFLATION BACKDROP
Current CPI inflation is running at approximately 3.4%. Interestingly, CPI finished 2023 at approximately the exact same 3.4%. But getting there was painful as inflation ran at about 7.0% at the end of 2021 and ultimately peaked at 9.1% in June 2022. Today inflation is nowhere near those levels, but the market remains extremely sensitive to anything that could cause inflation to accelerate again. Higher oil and energy costs are part of that concern. The Federal Reserve’s longer-term inflation target is approximately 2%, although technically the Fed measures that target using the PCE price index rather than CPI. So even though today’s inflation picture is dramatically better than it was in 2021 and 2022, the bond market is worried about where inflation may be going, not simply where it is today.
And mortgage rates tend to react very quickly to those expectations. Enough about why we are here. Now for the good stuff!

WHAT IS A TEMPORARY BUYDOWN?
A temporary buydown does NOT permanently change the interest rate on the mortgage. The borrower receives a 30-year fixed mortgage at the normal note rate. Someone then funds an account at closing that subsidizes a portion of the borrower’s mortgage payment during the first one, two or three years. That money can potentially come from the seller, builder, lender or another permitted source depending upon the loan program and transaction. The important thing to understand is the actual mortgage rate does not change. The temporary buydown simply lowers the buyer’s payment during the beginning of the loan.
And here is probably the MOST IMPORTANT rule – THE BUYER MUST QUALIFY USING THE FULL NOTE RATE.
If the note rate is 7.50%, we qualify them using 7.50%. We do not qualify them at 6.50%, 5.50% or 4.50% simply because their initial payment has been temporarily reduced. The buyer still has to qualify for the permanent payment. 

ONE IMPORTANT THING TO UNDERSTAND ABOUT THE COST
The cost of a temporary buydown is basically the amount of payment savings the buyer receives during the buydown period. In other words, if the buyer saves approximately $805 during the first year, approximately $805 needs to be deposited into the buydown account to create those savings.
So, throughout the examples below:

BUYER SAVINGS = APPROXIMATE COST OF THE BUYDOWN
The funds are deposited upfront and then used each month to make up the difference between the buyer’s reduced payment and the full payment at the note rate. 

LET’S LOOK AT THE NUMBERS
We are going to show everything PER $100,000 BORROWED.
Assumptions- 30-year fixed mortgage –  7.50% note rate – Principal and interest only – At 7.50%, the normal principal and interest payment = approximately $699.21 per month for every $100,000 borrowed.
So on a $500,000 loan you simply multiply these numbers by five.  On a $750,000 loan multiply them by 7.5. On a $1,000,000 loan multiply them by ten. 

THE 1/0 BUYDOWN
The 1/0 is the simplest temporary buydown. Your permanent note rate is 7.50%, but during the first year your payment is calculated as though your rate were 6.50%.
YEAR ONE
Payment at 6.50% = Approximately $632.07 per $100,000
Normal payment at 7.50% = Approximately $699.21
Monthly savings = Approximately $67.15 per $100,000
First year savings / approximate buydown cost = $805.76 per $100,000
After the first 12 months, the borrower begins making the normal payment based upon the 7.50% note rate.
On a $500,000 mortgage, that means the payment is $336 lower per month during year one. Approximately $4,029 of total first year payment assistance. 

THE 2/1 BUYDOWN
Again, assume the actual note rate is 7.50%.
YEAR ONE
Payment rate 5.50% = Approximately $567.79 per $100,000
Monthly savings = Approximately $131.43
First year savings / approximate buydown cost = $1,577.11 per $100,000
YEAR TWO
Payment rate 6.50% = Approximately $632.07 per $100,000
Monthly savings = Approximately $67.15
Second year savings / approximate buydown cost = $805.76 per $100,000
YEAR THREE AND BEYOND
The borrower makes the normal payment based upon the 7.50% note rate.
TOTAL APPROXIMATE 2/1 BUYDOWN COST = $2,382.87 per $100,000 borrowed.
That means approximately:
$500,000 loan = $11,914
$750,000 loan = $17,872
$1,000,000 loan = $23,829
And look at the first-year payment difference.
On a $500,000 mortgage, the buyer would temporarily have a payment approximately:
$657 lower per month during year one. 

THE 3/2/1 BUYDOWN
Now let’s talk about the buyer who says:
"Mike, I understand everything you are saying, but rates freak me out and I want THREE YEARS before I get to the full payment!"
Can we do that? YES!
A 3/2/1 buydown works like this with a 7.50% note rate: 

YEAR ONE
Payment rate 4.50% = Approximately $506.69 per $100,000
Monthly savings = Approximately $192.53
First year savings / approximate buydown cost = $2,310.35 per $100,000
YEAR TWO
Payment rate = 5.50% = Approximately $567.79 per $100,000
Monthly savings = Approximately $131.43
Second year savings / approximate buydown cost = $1,577.11 per $100,000
YEAR THREE
Payment rate 6.50% = Approximately $632.07 per $100,000
Monthly savings = Approximately $67.15
Third year savings / approximate buydown cost = $805.76 per $100,000
YEAR FOUR AND BEYOND
The borrower pays the normal payment based upon the 7.50% note rate.
TOTAL APPROXIMATE 3/2/1 BUYDOWN COST
$4,693.22 per $100,000 borrowed.
That means approximately:
$500,000 loan = $23,466
$750,000 loan = $35,199
$1,000,000 loan = $46,932
That is why the 3/2/1 normally requires a pretty substantial seller or builder credit.
But imagine being a buyer moving into a home today and having your first year’s payment calculated at 4.50% instead of 7.50%.
That gets people’s attention.
SELLER CREDITS CAN BE EXTREMELY POWERFUL
This is where temporary buydowns can also become an incredible negotiation tool for Realtors. Instead of simply asking the seller to reduce the sales price, a buyer may be able to negotiate a credit that funds part or all of the temporary buydown. A price reduction does not always create a dramatic monthly payment difference. A temporary buydown can. For the right buyer, using a seller credit to reduce the payment for one, two or three years may feel considerably more meaningful than simply reducing the purchase price.
Of course, seller concessions are subject to loan program limitations and the specific transaction. 

WHAT ABOUT A LENDER-PAID 1/0 BUYDOWN?
This is another option that can be extremely interesting. Instead of asking the seller to provide thousands of dollars toward the temporary buydown, we can sometimes structure a lender-funded 1/0. Here is an example of how that could work.
Let’s say normal no-point pricing is approximately 7.50% but we may price the permanent loan approximately .25% higher at 7.75%. That higher permanent rate can potentially generate enough lender credit to fund the temporary 1/0 buydown.
The borrower then receives a first-year payment calculated at approximately 6.75%
So while the standard loan might have been 7.50%, the borrower’s first-year payment is effectively calculated about 0.75% lower.
Here are the numbers per $100,000.
STANDARD 7.50% LOAN = Approximately $699.21
LENDER FUNDED EXAMPLE = Permanent note rate = 7.75% = Approximately $716.41
First year temporary payment rate at 6.75% = Approximately $648.60
That means the borrower saves approximately $50.62 per month during the first year compared with simply taking the 7.50% loan.
On a $500,000 mortgage, that is approximately $253 per month or $3,037 during the first year.
There is a trade-off.
If the borrower never refinances, the permanent 7.75% payment would be approximately $17.20 more per month per $100,000 than the original 7.50% loan.
On a $500,000 loan, that is about $86 more per month once the temporary buydown ends. So this strategy makes the most sense when the buyer values the immediate first-year payment reduction and understands the longer-term structure. 

IF RATES DROP, WE CAN REFINANCE
This is where temporary buydowns become especially interesting in today’s market. Nobody knows where mortgage rates will be next year. They could be higher, the same or lower. But imagine someone buying today with a 2/1 buydown.
Their payment is temporarily based upon:
5.50% in year one
6.50% in year two
7.50% thereafter
Then suppose mortgage rates decline enough during year one or year two to make refinancing worthwhile. We refinance the permanent mortgage. That means the buyer may never even reach the full 7.50% payment.
And for qualifying Augusta Financial clients, our Free Refi for Life program can make that future refinance even more attractive by eliminating many of the normal lender related refinancing costs, subject to program terms and eligibility. 

WHAT HAPPENS TO UNUSED BUYDOWN MONEY?
This is one of my favorite parts of the strategy, but it needs to be explained correctly. Temporary buydown money doesn’t simply disappear. The funds go into a buydown account and are used each month to supplement the borrower’s payment. If the homeowner refinances or sells the home and pays off the mortgage early, money may remain in that account. What happens to those unused funds depends upon the specific buydown agreement and who funded the buydown. Remaining funds may be credited toward the mortgage payoff, returned to the borrower, or returned to the lender, depending on how the program and agreement were structured. That means we always want to look carefully at WHO funded the buydown. If the seller funded it, the agreement may provide a benefit to the borrower upon early payoff. If the lender funded it, the agreement may allow unused funds to return to the lender. So, we never want to automatically tell a buyer that unused funds will simply come back to them in cash. We review the actual buydown agreement so the buyer knows exactly how the unused funds will be treated. 

WHICH BUYDOWN MAKES THE MOST SENSE?
There really is no single answer.
The 1/0 is inexpensive and simple.
The 2/1 gives the buyer two years to adjust to the payment and is probably the structure most people know.
The 3/2/1 creates the biggest initial payment reduction and gives the buyer three years to reach the full payment, but it requires much stronger credit.
The lender-funded 1/0 can be especially interesting when the seller does not have enough credit available or the buyer wants to preserve seller concessions for other closing costs.
The key is STRUCTURE.
Instead of simply asking:
"What is today’s mortgage rate?"
We should be asking:
What does the buyer want their payment to look like?
How much seller credit is available?
How much cash does the buyer want to preserve?
Does the buyer expect their income to increase?
Is the buyer moving from a significantly lower housing payment?
How long do they realistically expect to keep this mortgage?
If rates eventually decline, what is their refinance strategy?
Those questions can completely change how we structure the financing.

ONE LAST THING
A temporary buydown does not magically make an unaffordable house affordable.
Remember:
THE BORROWER STILL HAS TO QUALIFY USING THE FULL NOTE RATE.
But for a buyer who already qualifies and simply does not like today’s payment, temporary buydowns can create a much softer landing.
And in a market where buyers are struggling emotionally with rates, sellers are competing for buyers, builders are offering incentives and everyone is wondering what rates will look like one or two years from now, this may be one of the best environments we have seen in years for temporary buydowns.
Sometimes the answer is not waiting for rates to change.
Sometimes the answer is changing how we structure the loan.
Rates and programs are subject to change. All payment examples are approximate, principal and interest only, based upon a 30 year amortization, and shown for educational purposes. Actual rates, credits, costs, seller concession limits and eligibility depend upon the borrower, property, loan program and market conditions. 

Interest Rates
If I say no change, it may mean that rates are the same, so I am not going to say that! There is no change, and rates keep climbing every day! Yup, that’s the no change I am talking about. 

Loan Programs Snapshot

• Government loans (FHA/VA/USDA): in the low  7’s –
• Conventional (≤ $832,750): in the 7’s
• High-balance: in the 7’s
• Jumbo: In the 7’s
• Bridge Loans: 8.29%

Additional options:

• Bank statement loans (10% down+)
• P&L loans (20% down, no bank statements)
• 0% down options (620+ score)
• DSCR loans (15% down)
• Buydowns Available (3/2/1, 2/1, 1/0)
• Private Money loans – Hard Money  
• Construction Loans
• 203K loans
• Commercial Loans
• Fix and Flip Loans  

Rates subject to change without notice. 

Condo Update
Good news:
Nothing this week!  

Bad news:
Nothing new!

We love your Non-Warrantable Condo loans!!
Need help checking a condo? Call me, and we can look it up in real time.
Also:
Full California “naughty list” available here:
https://mikemeena.com/non-warrantable-condos/

If you or your clients, friends, or family need guidance, I'm here.

📞 661-291-2222 (Direct)
📞 661-714-6258 (Cell)
📞 661-260-2970 ext. 2222 (Office)
📧 Mike@AugustaFinancial.com

Sincerely,