Temporary Interest Rate Buy Down- A Popular Solution to Higher Rates

Understanding Temporary Interest Rate Buy Downs vs. Adjustable Rate Mortgages (ARMs)

When navigating the complex world of mortgages, understanding your options can save you thousands. Two commonly confused options are Temporary Interest Rate Buy Downs and Adjustable Rate Mortgages (ARMs). While both affect your payments in the early years, they differ significantly in structure and benefits. Here’s everything you need to know to make an informed decision.

What Is an Adjustable Rate Mortgage (ARM)?

An Adjustable Rate Mortgage (ARM) starts with a fixed interest rate for a set period, such as five years in a 5-year ARM. After this initial period, the rate adjusts annually based on market conditions, using an index and margin. Rate adjustments are capped, limiting how much your rate can increase or decrease within a period or over the loan’s life.

For example, a 5-year ARM locks in your rate for five years, then adjusts annually, potentially impacting your monthly payment significantly.

What Is a Temporary Interest Rate Buy Down?

A Temporary Interest Rate Buy Down offers a fixed interest rate for the entire loan term (e.g., 30 years) but temporarily lowers your effective payments through a subsidy in the initial years. This option provides short-term relief while maintaining long-term stability.

How It Works:

Fixed Rate Example: With a 30-year fixed rate of 6.5% and a 1-0 temporary rate buy down, your effective rate for the first year would be 5.5%.
The difference between the payments at 6.5% and 5.5% is prepaid into an escrow account at closing.
Monthly payments draw from this escrow, covering the subsidy and reducing your out-of-pocket cost.
After 12 payments, the escrow account is depleted, and you begin making full payments at the 6.5% rate.

Other Temporary Buy Down Structures

3-2-1 Buy Down Example:

Year 1: Rate reduced by 3% (e.g., 3.5%)
Year 2: Rate reduced by 2% (e.g., 4.5%)
Year 3: Rate reduced by 1% (e.g., 5.5%)
Years 4-30: Full rate (e.g., 6.5%)

2-1 Buy Down Example:

Year 1: Rate reduced by 2% (e.g., 4.5%)
Year 2: Rate reduced by 1% (e.g., 5.5%)
Years 3-30: Full rate (e.g., 6.5%)

Benefits of Temporary Interest Rate Buy Downs

Seller-Funded Buy Downs: These are especially attractive when the seller covers the cost, offering buyers a low-cost way to reduce initial payments.
Flexibility for Buyers: Ideal for those expecting increased income or lower expenses in the future.
Impact on Refinancing: If you refinance before the subsidy period ends, the remaining escrow balance reduces the payoff amount for your existing loan.

Permanent Rate Buy Downs vs. Temporary Buy Downs

Another way to reduce your rate is by paying points at closing for a permanent rate buy down. For example:

Paying points might reduce your rate from 6.5% to 6.25%, offering lifetime savings.
This option is also seller-funded in some cases, making it a valuable tool in negotiations.

Choosing the Right Option

To decide between a temporary and permanent buy down, consider:

Your Financial Goals: Temporary buy downs are great for short-term relief but require readiness for higher payments after the initial period.
Breakeven Analysis: For permanent buy downs, calculate the time it takes to recoup your upfront costs through monthly savings.
Market Trends: If interest rates are likely to decrease, a temporary buy down combined with refinancing could be more advantageous.

Maximize Your Savings with the Right Mortgage Strategy

Understanding the differences between Temporary Interest Rate Buy Downs, Adjustable Rate Mortgages, and Interest Rate Buy Downs, empowers you to choose the best option for your unique situation. Whether you’re looking for short-term payment relief or lifetime savings, working with an experienced mortgage broker like us ensures you’ll make the right choice for your financial future.

MMCJanuary 17, 2025Comment