Buy down, pay more later, a key to this mortgage plan

THE BALTIMORE SUN

What is a buy-down mortgage?

With a buy-down loan program, funds are put into an account at closing and are used to pay part of a homebuyer's mortgage payment each month. Funds for the account can come from the home seller, builder or buyer.

Buy-downs can be temporary -- for a period of 6 months to 3 years -- or permanent.

The buy-down amount is usually quoted as "points." (One point is equal to one percent of the loan amount).

Because of the lower initial mortgage payment, buy-downs make is easier for a buyer to qualify for a loan.

A common buy-down program is called a 3-2-1 buy-down.

Here's how it works. For the first year of the loan, the buyer pays an interest rate that is 3 percent below the note rate.

The note rate is the ultimate interest rate the borrower will pay at the end of the buy-down period.

During the second year, the interest rate is 2 percent below the note rate.

The rate is 1 percent below the note rate for year 3.

Thereafter, the buyer pays the note interest rate.

The cost to buy down a loan is usually 1 point a year for each 1 percent decrease in the interest rate.

The cost of a 3-2-1 buy-down will usually be 6 points paid to the lender at closing (3 points for the first year buy down, 2 points for the second year and 1 point for the third year).

In addition to paying an upfront charge to buy down the interest rate, the borrower usually agrees to pay a higher note rate than would be the case with a conventional mortgage.

For example, let's say the going rate on a conventional 30-year fixed-rate mortgage is 9.5 percent. On a 3-2-1 buy-down program, you might pay 7.5 percent for the first year, 8.5 percent for the second and 9.5 for the third. When the buy-down period is over, you might pay 10.5 percent for the remainder of the loan.

One of the benefits of a buy-down loan is that at the end of the buy-down period, the interest rate is fixed for the remainder of the loan. The interest rate on an ARM can increase 5-6 percent over the term of the loan. In today's market, if you take an ARM, your interest rate could rise to a life-time cap of 12 percent or more. With the buy-down in the above example, your rate will never be higher than 10.5 percent.

FIRST-TIME TIP: Most lenders will allow you to design your own buy-down loan. That is, you can decide how long you want the interest rate to be reduced, how much the rate will be reduced, how many points you'll pay and how often the interest rate will adjust (for example, every 6 months or annually). It's possible to pay fewer points for a buy-down in exchange for a higher interest rate or a shorter buy-down period.

THE CLOSING: Buyers who don't intend to own their homes for very long will probably save money by taking an ARM rather than paying the cost to buy down an interest rate. Sometimes, however, a seller or builder may be willing to pay the upfront buy-down fee for you. When real estate markets slow, you'll find more sellers willing to pay to buy-down a rate for a buyer. But if you can qualify for a loan without a buy-down, you'll probably be better off negotiating a lower purchase price rather than asking the seller for a buy-down concession.

Dian Hymer's column is syndicated through Inman News Features. Send questions and comments care of Inman News Features, 5335 College Ave., No. 25, Oakland, Calif. 94618

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