Yesterday, I talked about seller buy-downs, where the seller pays a lender to lower the buyer's rate. Although the rate can be bought down for the life of the mortgage, it is far more common to see sellers buy down the rate for the first two or three years of the mortgage.
This financial tool all but disappears during strong markets like the one we have now. After all, who needs them when potential buyers are bringing in multiple offers? But in slower markets, buy-downs return with a vengeance, and you don't have to pay for it in advance, so there's no cash out of pocket...it all comes out at closing.
The object of a temporary buy-down is to bring the initial rate down to a point where the buyer can either qualify for financing or can't resist the lower monthly payment. Generally, they come in two versions:
-- 3-2-1 -- Under this model, the rate is bought down by the sellers to three percentage points below the market for the first year, 2 points for the second year and 1 point for the third.
-- 2-1 -- This truncated version works the same way except that the rate is bought down by two percentage points in the first year and 1 point for the second year.
In both cases, once the buy-down period ends, the rate returns to where it would have been had there been no reduction. So, if the market rate for a fixed-rate loan is 6 percent, a 3-2-1 buy-down would result in a 3 percent start rate. Then, the rate would move to 4 percent during the second year and 5 percent for the third. After three years, the rate would be back to 6 percent for the remaining term.
A third version is a permanent one in which the rate is bought down just enough to make the property stand out -- but for the entire life of the loan.
This can be a win-win solution. It costs the seller less than a major price reduction, and saves the buyer more.
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