Buydowns aren’t used too much, these days. Back in the early 1990’s, they were more common (yes, I know this, I worked in a mortgage loan department, at the time).
Here’s how it works:
You make an offer on a property, below asking. The seller declines to lower the price, but says he is willing to do a buydown with you. You like this, because it lowers your monthly mortgage loan payment, during the first two or three years, and the seller likes it, because he ends up paying less to do the buydown than he would if he simply gave you a lower purchase price.
Say you want to buy a home that is on the market for $210,000.
You offer $200,000. The seller says no, but says he is willing to do a buydown (not sure how to phrase that).
The seller’s money is set aside in a lump sum escrow account that is drawn on each month to make the mortgage payment.
Suppose you find a fixed-rate mortgage in the 6.5% range. The buydown brings the effective rate to 3.5%. This means your monthly payment would be $898, instead of $1,264. The seller kicks in $366, per month.
You pay less, out of pocket, every month, during year one.
In the second year, your rate would rise by a percentage point, to 4.5 percent. You pay around $1,013 per month, the seller kicks in $251 a month.
In the third year, the rate for the buyer would rise to 5.5 percent. You pay $1,135, with the seller kicking in $129 a month.
By the fourth year, you are responsible for the entire payment.
The seller ends up putting in less than the $10,000 you asked for – around $8,900. You end up with lower loan payments over the first three years.
As you can imagine, the higher the original purchase price, the more savings you may be able to enjoy.
But, here’s the best part:
Fannie Mae’s guideline allows buyers to qualify for mortgages at the first-year rate – 3.5 percent in this example – if the home will be a primary residence and the borrower’s FICO credit score is 660 or higher.
This means you may qualify for a home you might not otherwise be able to afford (whether or not you should do so, is another matter).