3-2-1: Unlocking the Mystery of Seller Contributions in Mortgage Buydowns
The Scoop on Seller Contributions and Buydowns: Savings!
If you’ve dipped your toes in the home buying world, you’ve probably come across the term “seller contributions or concessions and rate buydowns". In today's rate driven housing markets, seller concessions and rate buydowns can save a new home buyer tens of thousands of dollars and lower monthly payments for up to 3-years!
What is a 3-2-1 buydown and how much can it save a new homebuyer?
A 3-2-1 buydown is a type of mortgage interest rate buydown where the interest rate is reduced by 3% in the first year, 2% in the second year, and 1% in the third year. After the third year, the rate returns to the original or "par rate."
Let's break this down for a $500,000 home:
If you have a mortgage at the par rate of 7% for the full term, then your interest for the first three years would be calculated at this 7% rate.
With 3-2-1 Buydown:
First Year: Interest rate is reduced by 3%, making it 4%.
Second Year: Interest rate is reduced by 2%, making it 5%.
Third Year: Interest rate is reduced by 1%, making it 6%.
Interest Cost Comparison Without Buydown (at 7%):
1st Year: $35,000
2nd Year: $35,000
3rd Year: $35,000
Total 3-Year Interest = $105,000
Interest Cost Comparison (at 7%) With 3-2-1 Buydown:
1st Year (at 4%): $20,000
2nd Year (at 5%): $25,000
3rd Year (at 6%): $30,000
Total 3-Year Interest = $75,000
$105,000 (without buydown) - $75,000 (with buydown) = $30,000 saved in interest over the first three years.
So, with the 3-2-1 buydown on a $500,000 home, the homeowner would save roughly $30,000 in interest over the first three years compared to not having a buydown. This type of buydown can be particularly helpful for homeowners who are shopping in today's housing markets.
Let's determine how the 3-2-1 buydown would affect the monthly Principal & Interest (P&I) payments on a 30-year fixed mortgage for a $500,000 home.
Remember, for this example, we're focusing solely on the Principal and Interest portion of the mortgage payment.
At a 7% interest rate for 30 years on a $500,000 loan, the monthly P&I payment would be approximately $3,327.76.
With 3-2-1 Buydown:
First Year (at 4% rate): Monthly P&I is about $2,387.08.
Second Year (at 5% rate): Monthly P&I is about $2,684.11.
Third Year (at 6% rate): Monthly P&I is about $2,997.75.
Year 1: 12 months x $3,327.76 = $39,933.12
Year 2: 12 months x $3,327.76 = $39,933.12
Year 3: 12 months x $3,327.76 = $39,933.12
With 3-2-1 Buydown:
Year 1: 12 months x $2,387.08 = $28,644.96
Year 2: 12 months x $2,684.11 = $32,209.32
Year 3: 12 months x $2,997.75 = $35,973.00
Year 1: $3,327.76 - $2,387.08 = $940.68
Year 2: $3,327.76 - $2,684.11 = $643.65
Year 3: $3,327.76 - $2,997.75 = $330.01
Total Savings Over 3 Years:
($39,933.12 - $28,644.96) + ($39,933.12 - $32,209.32) + ($39,933.12 - $35,973.00) = $11,288.16 + $7,723.80 + $3,960.12 = $22,972.08
Thus, by utilizing the 3-2-1 buydown, the homeowner would save a total of $22,972.08 on P&I payments over the first three years. This significant saving can make the initial years of homeownership more manageable financially.
FYI: Seller concessions are paid by the seller. Buydowns have become more common as rates have risen.
What are seller concessions and how can they save homebuyers thousands of dollars?
These are essentially a helping hand from the seller to cover some of your closing costs, which can include the exciting possibility of interest rate buydowns. But there’s a catch (isn’t there always?) – there are limits to how much sellers can contribute, and it varies depending on the type of loan you’re going for.
Maximum seller contributions rules vary based on the type of loan and the down payment percentage.
Here's a general breakdown for some popular loan types:
1. Conventional Loans (backed by Fannie Mae and Freddie Mac):
Down payment of 10% or less: The maximum seller concession is 3% of the purchase price.
Down payment between 10.01% and 25%: The maximum seller concession is 6% of the purchase price.
Down payment of 25% or more: The maximum seller concession is 9% of the purchase price.
2. FHA Loans:
The maximum seller concession is 6% of the purchase price.
3. VA Loans:
Seller concessions are limited to 4% of the loan amount. It's worth noting that VA loans have a broader definition of what's considered a "concession."
4. USDA Loans:
Typically, seller concessions are limited to 6% of the purchase price.
When using seller contributions for buydowns, it's essential to ensure that the contributions don't exceed these limits when combined with other closing costs that the seller agrees to pay. Otherwise, the excess must be returned to the seller, used to reduce the sales price, or applied in a manner allowed by the specific loan program.
Delving Deeper: VA Loans and the Definition of "Concessions"
The Veterans Affairs (VA) loan program stands out for many reasons, one of which is its unique treatment of seller concessions. While other loan types have more straightforward definitions of seller concessions, the VA loan program expands the term to cover a broader range of costs.
1. Traditional Seller Concessions:
Just like with other loan types, the VA loan program recognizes traditional concessions. These typically include contributions towards the buyer's closing costs, such as origination fees, appraisal costs, and more. However, the VA limits these traditional concessions to 4% of the loan's value.
2. Beyond the Traditional:
What sets VA loans apart is the range of costs that can be covered by the seller, which do not count toward this 4% cap.
Prepaid Expenses: This could involve the seller covering property taxes or homeowners' insurance premiums for the buyer.
VA Funding Fee: The seller may choose to pay the VA Funding Fee on behalf of the veteran buyer.
Temporary Interest Rate Buydowns: Sellers can also fund buydowns, which temporarily reduce the buyer's interest rate.
Outstanding Debts or Collections: In some circumstances, sellers can even pay off some of the buyer's debts or collections to help them qualify for the loan.
3. The Importance of Understanding Limits:
While the VA program offers flexibility, it's essential to ensure that total seller concessions do not exceed the 4% cap. Remember, the items listed in the "Beyond the Traditional" section above do not count towards this cap, which can offer significant benefits to veteran homebuyers.
Let's Talk, Reach Out for Expert Guidance!
Navigating the intricacies of seller contributions and mortgage buydowns requires expertise. As a licensed mortgage broker, I encourage you to contact me for guidance tailored to your specific scenario,
Call or message now for professional assistance. (719) 930-9846.