So, you've found the perfect house, but the price is a bit higher than you were hoping for. But wait - the seller has just announced that they're willing to lower the price! Your first thought might be to jump at the opportunity and accept the lower price, but before you do, there's something you should consider.
In many cases, instead of lowering the price, sellers may offer concessions to help buyers with the costs associated with purchasing a home. These concessions are essentially funds paid by the seller towards the buyer's closing costs. One specific type of concession is known as a rate buydown, which can help buyers lower their mortgage interest rate in the first few years of owning the home.
Let's take a closer look at how a rate buydown works. Say you're looking at a home that's listed at $620,000.
Now, let's say the seller offers to reduce the purchase price to $600,000 and you're putting down 5% and a $570,000 loan. Let’s use an interest rate of 6.5% for example purposes.
$570,000 Loan at 6.5%: Principal and interest (P&I)payment= $3603/mo
Annual payment at 6.5%: $3,603 x 12 = $43,236
While this may seem like a great deal, it's important to consider other options. Instead of a lower purchase price, you could ask the seller to provide selling concessions in the form of a rate buydown.
A rate buydown is when the seller pays upfront to reduce the buyer's interest rate. One popular option is a 2-1 buydown, which means that the interest rate is reduced by 2% in the first year and 1% in the second year. So instead of a 6.5% interest rate, the buyer would pay a 4.5% interest rate in the first year, and a 5.5% interest rate in the second year.
Let's say you decide to go with the rate buydown option instead of the lower purchase price. The seller agrees to provide a 3% seller concession (the maximum on conventional with 5% down) or $18,600 in seller concessions. You want to look at using these proceeds towards a 2-1 buydown:
2-1 Buydown Option:
Year 1:
Monthly (P&I) payment at 4.5%: $2,984
Annual (P&I) payment at 4.5%: $2,984 x 12 = $35,808
Year 2:
Monthly (P&I) payment at 5.5%: $3,344
Annual (P&I) payment at 5.5%: $3,344 x 12 = $40,128
Years 3 going forward
Monthly (P&I) payment at 6.5%: $3,723
Annual (P&I) payment at 6.5%: $3,723 x 12 = $44,676
The interest savings in the first two years of the buy down can be calculated by taking the annual P&I payments on the lowered cost scenario:
$43,236x 2 = $86,472
Less the annual P&I payments in year 1 and year 2 of the buydown:
$35,808 + $40,128 = $75,936
Savings: $86,472 - $75,936 = $10,496 less $1000 (the difference in the down payment of $30,000 for the $600k purchase price and $31,000 for the $620k purchase price) = $9496
To calculate the total cost of the buydown, you would add up the difference between the two annual payments and what the sum of the annual payments at the 6.5% interest rate for the first two years. In this case, the cost of the buydown would be just over $13,400.
($44,676 - $35,808) + ($44676 - $40,128) = $13,416
Now, at the beginning we discussed a seller concession of $18,600.
$18,600 (3% seller concession) - $13,400 (cost of 2/1 buydown) = $5200 (balance of seller concessions which can go towards closing costs)
Now to tie this together: The total savings in the first two years is the interest savings (or difference in P&I payments) : $10,496 less the $1000 in higher down payment less the $5200 in additional closing costs covered by the seller = $15,500 (approximate figure also taking into account nominal difference in PMI payments).
Now to finish this off, I like to take into consideration the breakeven and/or payback period. From Year 3 forward, you would be paying approximately $120/mo more in your monthly P&I payment under the buy down scenario. If you take the total savings of $15,500 in the first two years and then calculate the breakeven:
$15,500 / $120 = 129 months. Thus we are looking at over 10 years to recoup that up front out of pocket savings by taking the lower purchase price. Then add back the 1st two years of the lowered payments and the actual payback period is over 12 years.
I am not sure about you, but in this scenario I would take the selling concessions all day long. Especially when you take into account the fact that most people stay in their home on average closer to 7 years, I would rather keep that upfront money in my pocket.
Of course, every situation is unique, and there are many factors to consider when purchasing a home. However, it's important to keep in mind that a lower purchase price may not always be the best option. By exploring other options like seller concessions and rate buydowns, you may be able to save money in the long run and make your dream of owning a home a reality.
Have questions or thoughts: Comment or contact me!
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