Uncover the secrets behind seller-funded buydowns and gain a comprehensive understanding of how they work in real estate transactions.
What are Seller Funded Buydowns?
Seller funded buydowns are a type of financing arrangement commonly used in real estate transactions. In simple terms, a buydown is a temporary reduction in the interest rate of a buyer's mortgage loan, which is funded by the seller of the property via a seller's credit. This means that the seller contributes a certain amount of money upfront to lower the monthly mortgage payments for the buyer during the initial years of the loan. The term can be anywhere from one to a maximum of three years.
The purpose of seller funded buydowns is to make the property more affordable for the buyer in the early stages of homeownership. By reducing the interest rate during the early stages of the loan, the monthly mortgage payments are lowered, allowing the buyer to allocate more funds towards other expenses or savings.
How Seller Funded Buydowns Work
Seller funded buydowns involve a series of calculations and agreements between the buyer, seller, and the lender. Here's a step-by-step breakdown of how they work:
Agreement: The buyer and seller agree on the terms of the buydown, including the duration of the rate reduction period and the amount of the interest rate reduction.
Contribution: The seller contributes a certain amount of money to an escrow account, held by the lender, which is used to make the necessary payments to the lender during the rate reduction period.
Lower interest rate: The lender adjusts the interest rate on the mortgage loan, based on the agreed-upon reduction. This lower interest rate is applied for the duration of the buydown period.
Temporary reduction: During the buydown period, the buyer enjoys lower monthly mortgage payments, as the interest rate is reduced.
Transition period: At the end of the buydown period, the interest rate reverts back to the original rate, and the buyer resumes making the normal monthly mortgage payments.
It's important to note that the specifics of seller funded buydowns can vary depending on the terms negotiated by the buyer and seller, as well as the guidelines set by the lender.
How buydowns are structured and what effect does it have on the buyer's monthly payment?
Most buydowns are structured like this:
On a 3-2-1 buydown, the first year's interest rate is reduced by 3% from the note rate, with the second year reduced by 2%, and the third year is reduced by 1% from the note rate. The remaining 27 years of monthly payments are based on the original note rate.
The Principal and interest portion of the original monthly payment is reduced the first year by about 28-29%, with the second year reduced by 18-19% and the third year reduced by 8-9%. However, these percentages are just ballpark, with the actual reduction in monthly payment dependent on the original note rate.
The idea is a buyer will either have more income after this buydown period --or interest rates--near all time highs right now, will drop substantially, allowing for a refinance to lower the monthly payment permanently.
Rates are very likely to cycle downwards, however, contrary to what many loan officers state in "pushing" temporary rate buydowns as a great tool in affordability, there is no guarantee rates will drop --or to what level going forward. It is important buyer's understand this and plan for the potential of higher monthly payments in the future-when the buydown term expires.
What happens to the buydown funds if a buyer refinances or sells the home prior to the 3 years-and before all the seller funded buydown money is utilized? Any remaining buydown funds are the property of the buyer and would be credited to the current loan payoff.
Factors to Consider Before Opting for a Seller Funded Buydown
While seller funded buydowns can offer benefits, it's essential to consider the following factors before opting for this financing arrangement:
Cost: The seller funded buydown requires the seller to contribute a certain amount of money upfront as a seller credit to the buyer at closing. This amount to fund the buydown will vary based on the term of the buydown and the buyer's interest rate at the time of closing. Typically a 3 year buydown will require a seller credit of 3-4% of the sales price as an example. The higher current rates are, the more seller credit is required to fund the buydown.
An experienced loan officer can provide the buyer and buyer's agent an exact amount of seller credit needed. It's important for the buyer and seller to carefully evaluate the cost and ensure it aligns with their financial goals.
Duration: The duration of the buydown period should be considered. Buyers should assess whether the temporary reduction in interest rates is beneficial for their specific situation and whether they can afford the regular mortgage payments once the buydown period ends.
Market conditions: The current real estate market conditions should be taken into account. Depending on the market, a seller funded buydown may or may not be necessary to attract buyers. It's crucial to evaluate the competitiveness of the market and consult with real estate professionals for guidance.
Seller's motivation: Understanding the seller's motivation for offering a buydown is important. It could be a sign that the seller is eager to sell the property quickly or that there are certain challenges associated with the property.
Careful consideration of these factors can help buyers make an informed decision about whether a seller funded buydown is the right choice for their specific circumstances.
Common Misconceptions About Seller Funded Buydowns
There are some common misconceptions surrounding seller funded buydowns that should be clarified:
It's a form of down payment: Seller funded buydowns should not be confused with down payments or the buyer's share of closing costs. However any seller funds credited to the buyer-not needed for a rate buydown--can be used as a credit for other buyer closing costs--depending of course on the sales contract terms.
It's only for buyers with low credit scores: Seller funded buydowns can be beneficial for buyers with all credit scores. It's not limited to buyers with low credit scores but can be advantageous for any buyer looking to reduce their monthly mortgage payments.
It's only for first-time buyers: Seller funded buydowns are not exclusive to first-time buyers. Any buyer, regardless of their homeownership history, can consider a buydown to make their mortgage payments more affordable.
It's a complicated process: While seller funded buydowns involve calculations and agreements, they are not necessarily more complicated than other financing arrangements. Working with an experienced loan officer can help simplify the process and ensure a smooth transaction.
Some final things to be aware of
Not all lenders offer seller funded temporary rate buydowns. And some that do offer buydowns have limitations based on their company overlays. Overlays are stricter deviations from loan underwriting guidelines provided to lenders by Fannie, Freddie, VA, FHA and USDA.
As of this writing, seller funded temporary rate buydowns are not eligible for non owner properties.
The maximum percentage of the sales price a seller can credit to the buyer is limited based on loan type, percentage of down payment and the buyer's occupancy type. Most of the time it's 6% of the sales price or less. However, for example, a conventional loan with a loan to value of 90.01% or greater is limited to 3%. Always consultant an experienced loan officer to help structure a rate buydown based on a transaction's terms.
Hopefully this article has provided a clearer understanding of seller funded buydowns and the benefits they offer.