What is a Buy Down ?

By Dian Hymer

Ready to buy a home but worried about rising interest rates? A mortgage with a buy-down option may be just the ticket.

Interest rates have risen substantially during the past year. Today, 30-year fixed-rate mortgages carry an interest rate of over 8.25 percent. This is about 1 percent higher than last year's rate. As interest rates rise, so does the monthly mortgage payment. This makes qualifying for a home mortgage more difficult.

To make matters worse, in many areas of the country, home prices are still rising. So housing becomes even less affordable. In years past, when homebuyers were faced with declining affordability, they simply switched from fixed- to adjustable-rate financing. Today, that strategy doesn't provide much relief.

Most adjustable-rate mortgages (ARMs) are tied to short-term interest rates. In the past, short-term rates were often as much as 2 percent below long-term rates. But today, short-term rates are close to or even higher than long-term rates.

Some ARMs offer a discounted “teaser” rate initially. But after the teaser rate expires -- in anywhere from one month to one year -- the interest rate will probably be close to the rate on a 30-year fixed-rate loan. Also, most ARM lenders qualify borrowers based on the note interest rate, not on the teaser rate.

First Time Tip: A new mortgage product provides relief for homebuyers who are caught in an affordability bind. The ARM buster offered by Cendant Mortgage offers a fixed-rate around 8 percent for the first 10 years of the loan. After 10 years, the loan converts to an ARM for the remaining 20-year term of the loan. An attractive feature of this loan is that there is a 2/1 buy-down option, which lowers the interest rate for the first two years.

With a buy-down loan program, funds are put into a subsidy account at closing and are used to pay part of the borrower's mortgage payment each month. With a 2/1 buy-down, the interest rate is lowered by 2 percent for the first year of the loan and by 1 percent for the second year.

The Cendant ARM buster is available to buyers who have at least a 10 percent down payment and a credit score of 620 or more. The lender charges 2 percent of the loan amount as a loan origination fee. The interest rate for the first year is 6.25 percent. The second year rate increases to 7.25 percent. Starting with the third year, the interest rate is 8.25 percent and it's fixed at this rate for the next 8 years. Starting with year 11, the loan converts to an ARM that adjusts annually.

Unlike most ARMs, buyers are qualified for the ARM buster based on the initial, 6.25 percent interest rate. This makes qualifying easier.

Many lenders will allow you to design your own buy-down mortgage. That is, you can decide how much you want to buy-down the interest rate and for what period of time. Lenders usually adjust the amount of points they charge you to help fund the buy-down.

A “point” is the term lenders use for the loan origination fee. One point is equal to 1 percent of the mortgage amount. So by increasing the number of points, you can buy down the interest rate to a lower rate or you can buy the rate down for a longer period of time.

The Closing: In slow real estate markets you may be able to negotiate for the seller to pay some or all of the points to buy down your interest rate.

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