When you buy a home, you have many options when it comes to financing. Many people assume they have to have 20% down and must have great credit. This isn’t the case. There are many loan programs available including FHA, VA, USDA, and conventional loans.
Each loan program mentioned above is different, but they have one thing in common. You can make them a ‘buy down mortgage.’ In other words, you can pay money to get a lower payment. That sounds counter-intuitive, but it can help you qualify for a mortgage if you are on the fritz of a loan denial.
Keep reading to see if the buy down mortgage is right for you.
How Does a Buy Down Mortgage Work?
If you need a buy down mortgage, you’ll need to pay some cash in advance. This advance payment helps to lower your monthly mortgage payments. The payment may come from you, the seller, or even the builder.
Mortgage buy downs help you lower your interest rate and/or payment for a specific term. The lender will give you a ‘real note rate.’ This is your actual interest rate that you will pay for the portion of the term that isn’t subject to the buy down. You will also have a ‘buy down rate’ this is the rate that you pay in exchange for the cash payment of the difference. The amount you pay is the difference between the total cost of the interest between the two rates for the specified term.
Some lenders allow you to spread the difference out over the specified term, making your payments slightly higher, but not as high as they would be with a higher interest rate.
You can opt from two different types of buy down mortgages – a temporary buy down or permanent buy down. Understanding the difference is important to help you make the right choice for your situation.
What is a Temporary Buy Down Mortgage?
As the name suggests, a temporary buy down mortgage buys your interest rate down for a few years. The most common buy down mortgage is the 3-2-1. During the first year of the program, the interest rate is 3% lower than the note rate. The second year, the rate increases 1%, to make it 2% lower than the note rate. The third year is the final year; the rate is 1% lower than the note rate. For the remaining 27 years of the 30-year term, the rate remains at the note rate.
Another option is the 2-1 buy down mortgage. This is a shorter buy down program, as the rate is 2% lower than the note rate during the first year and then 1% lower than the note rate for year two. At year three, the interest rate increases to the note rate and stays there for the remainder of the term.
The temporary buy down is often a good choice for borrowers that know their income will increase over the years. For example, doctors start out with low pay, but then as they gain their experience, their income changes drastically, making it easier to afford the note rate. Rather than having to wait until their income is higher, though, they can buy the home now and work their way through the buy down program.
The Permanent Buy Down Mortgage
If you would rather permanently buy down your mortgage, you’ll pay points for the loan. This will buy the rate down for the entire term. One point equals one percent of the loan amount. On a $200,000 loan, two points would cost $4,000.
You pay the points upfront at the closing. The lender uses this money to supplement the interest they won’t make by giving you the lower interest rate. Each lender will have a different rate they will give you for each point that you pay. It’s important to shop around to find the best deal if this is the road you want to take.
Who Should Use Mortgage Buy Down Programs
Typically, only buyers that know they will stay in the home for the long-term benefit from the buy down program. It doesn’t make sense to buy down a loan that you will only have temporarily. You pay extra money to buy the rate down, if you don’t stay in the home long enough to recoup that money, you lose it.
Before you choose the buy down program, look at all of your options. It pays to see what lenders will give you as your note rate. You should also explore your options for an adjustable rate loan. You may be able to qualify for a much lower initial rate than you would get with the buy down and you don’t have to pay for it. Compare all of your options to decide which loan is right for you.