Affordability is one of the biggest challenges for consumers in the real estate market. Between mortgage rates and the steady rise in housing prices, buying a home can be a struggle, especially for first-time buyers.
However, with inventory on the rise, there are opportunities to overcome affordability struggles if sellers are willing to negotiate. Utilizing temporary or permanent rate buydowns can also help to reduce your monthly payment significantly. Let’s analyze a hypothetical transaction where you have the option to lower the purchase price, or permanently buy your rate down by 1% - which would save you more in the long run?
Again, this is a hypothetical scenario - to lower the purchase price, the seller would have to be willing to negotiate. And to buy your rate down, that could also be a result of negotiations, or you can explore this option with your lender.
Imagine you’re buying a $800,000 home with a 30-year fixed rate mortgage at 7%, and a 5% or $40,000 down payment. Your monthly payment would be roughly $5,056.30.
Now let’s take a look at how your monthly payment would shake out if you lowered the purchase price by $25,000. You’re now buying a $775,000 home, keeping the 30-year fixed mortgage at 7%, and your 5% down payment would be $38,750. This would bring your monthly payment from $5,056.30 down to $4,898.29, which would save you $158.01/month, or $1,896.12/year. If the listing has been on the market for longer than average, the seller may be willing to entertain this type of offer, and save you tens of thousands over the life of your loan.
So how would this compare to a permanent 1% rate buydown? Keeping all numbers the same, you’re buying a $800,000 home with a 30-year fixed-rate mortgage. But in this scenario, you’ve either negotiated a concession from the seller to pay for that 1% rate buydown, or worked with your lender to buy it down yourself at closing.
When talking rate buydowns, you may have heard the term ‘points’ or ‘discount points’ used by a lender. One point typically costs 1% of your total loan amount, and can drop the interest rate by .250% - .375%. However, the exact percentage depends on your lender, the loan type and housing market.
For example, if your loan amount is $800,000, it would take three to four discount points to permanently buy your rate down from 7% to 6%, which would cost you (or the seller) somewhere between $16,000 - $20,000 at closing. For the sake of comparison, let’s keep our cost the same and say it’s $25,000.
Your monthly payment would now be $4,556.58, which is $341.71 less each month than if you were to reduce the purchase price by $25,000. Below is how each scenario would play out:
No Price Reduction or Rate Buydown
- $800,000 home purchase | 5% down | 7% 30-year fixed | $5,056.30 monthly payment
$25,000 Price Reduction
- $775,000 home purchase | 5% down | 7% 30-year fixed | $4,898.29 monthly payment
1% Permanent Rate Buydown
- $800,000 home purchase | 5% down | 6% 30-year fixed | $4,556.58 monthly payment
Obviously, the 1% permanent rate buydown would save you the most money in the long term. However, it’s important to remember that a lot of this is dependent on whether the seller is willing to negotiate. Again, with affordability being one of the main challenges for buyers, spending more out of pocket to buy your rate down might not be a realistic option.
But with more homes on the market, listings are sitting longer on average, which will result in more sellers having to be flexible to sell their homes. Keep these options in mind - whether it’s a price reduction or a rate buydown – could be the perfect solution to help you afford your next home purchase.
