A Seller Credit May Help More Than a Price Cut: How Temporary Rate Buydowns Work

 A Seller Credit May Help More Than a Price Cut: How Temporary Rate Buydowns Work

When buyers negotiate on a home, one of the first things they usually think about is getting the seller to lower the price.

There is nothing wrong with that.

But depending on your situation, there may be a better use of the seller’s money.

A seller credit used for a temporary mortgage rate buydown can sometimes reduce your monthly payment much more during the first couple of years than taking the same amount off the purchase price.

This is something I like to look at with buyers because the best deal is not always simply the lowest purchase price.

Sometimes it is the structure of the financing.

What Is a Temporary Rate Buydown?

A temporary rate buydown uses money contributed at closing to reduce your effective mortgage payment for a set period of time.

One of the most common versions is a 2/1 buydown.

For example, if your actual mortgage note rate is 7.375%:

• Year 1 payment is calculated as though the rate were 5.375%

• Year 2 payment is calculated as though the rate were 6.375%

• Beginning in Year 3, you make the regular payment based on the 7.375% note rate

The mortgage itself is still a fixed rate loan at 7.375%.

The buydown funds are set aside at closing and used each month to make up the difference between the reduced payment and the actual mortgage payment.

There are also 1/1 buydowns, where the payment is reduced by 1% during the first year before returning to the full payment.

What Can That Mean in Real Dollars?

Let’s use a $700,000 loan as an example.

At a 7.375% fixed rate, the principal and interest payment would be approximately:

$4,835 per month

With a 2/1 temporary buydown:

Year 1 at an effective 5.375% payment: approximately $3,920 per month

That is a savings of about:

$915 per month

Then in Year 2:

Effective 6.375% payment: approximately $4,367 per month

That is still about:

$468 per month lower

Beginning in Year 3, the payment returns to the regular payment based on the original note rate.

In this example, the total cost of funding the 2/1 buydown would be approximately $16,600.

That money could potentially come from a negotiated seller credit, subject to the loan program and allowable seller contribution limits.

Why Can This Be Better Than a Price Reduction?

This is where the numbers can surprise people.

Suppose a seller is willing to negotiate approximately $15,000 to $17,000.

One option is reducing the price of the home.

Another option may be using that money toward the buyer’s closing costs and a temporary rate buydown.

A price reduction certainly has value. It reduces the amount you borrow and provides savings over the life of the loan.

But a modest price reduction usually does not dramatically change the monthly payment.

A temporary buydown concentrates the benefit into the first year or two, when many buyers appreciate the additional breathing room the most.

That can be especially useful after purchasing a home, when you may also be dealing with moving expenses, furniture, improvements, repairs, and rebuilding savings after closing.

You Still Have to Qualify at the Full Payment

This is important.

A temporary buydown does not allow you to qualify based on the reduced first year payment.

For conventional financing, we generally still qualify you using the actual mortgage note rate and full payment.

I actually think that is a good thing.

The goal is not to stretch someone into a home they cannot afford.

The goal is to create some additional breathing room during the first couple of years while still knowing the regular payment works within the overall budget.

What Happens If Rates Come Down?

This is another reason temporary buydowns can be attractive.

Nobody knows where mortgage rates will be a year or two from now.

If rates come down enough to make refinancing worthwhile, we can look at refinancing at that time.

If rates stay where they are or move higher, you still have the fixed rate mortgage you originally locked in.

A temporary buydown should never be based on the assumption that you have to refinance later.

If refinancing becomes beneficial, great.

If it does not, we already know the regular payment works.

What Happens to Unused Buydown Funds If You Refinance or Sell?

The exact treatment depends on the buydown agreement and loan terms.

Generally, if the mortgage is paid off before all of the temporary buydown funds have been used, the remaining funds are handled according to the written buydown agreement and may be applied toward the payoff or otherwise distributed as permitted under the agreement.

This is something I review with buyers when we structure the loan.

Should You Ask for a Price Reduction or a Seller Credit?

There is no automatic answer.

It depends on what you are trying to accomplish.

If your priority is lowering the loan balance for the long term, a price reduction may make more sense.

If your priority is reducing your monthly housing expense during the first year or two, a temporary buydown may provide considerably more immediate benefit.

You can also sometimes do a combination.

The seller could agree to a smaller price reduction along with a credit toward closing costs or a temporary buydown.

That is why I like to run the numbers before the offer is written.

A $15,000 price reduction and a $15,000 seller credit do not necessarily have the same impact on your monthly budget.

Look at the Financing Before You Negotiate

This is one of the areas where having your lender and Realtor communicating before the offer is written can really help.

If we know a seller is willing to negotiate, I can run different scenarios showing:

• A price reduction

• A temporary 1/1 or 2/1 buydown

• A permanent rate buydown

• Closing cost credits

• A combination of the above

Then you can see the actual payment and cash required for each option.

There is no reason to guess.

Sometimes the best deal is a lower price.

Sometimes it is a seller credit.

And sometimes a creative combination gives you the best overall result.

The important thing is understanding the numbers before deciding what to ask for.

Start With the Payment That Works for You

Buying a home is not just about getting an offer accepted.

It is about putting together financing that works comfortably for you after you get the keys.

If a seller is willing to negotiate, let’s look at all of the options and use that negotiation where it will help you the most.

Sometimes a seller paid temporary rate buydown can make a much bigger difference than simply lowering the purchase price.

And that is worth looking at before you write the offer.