Nov 28, 2022
Interest Buy Down – A Financing Option
Home prices might be going down, but unfortunately, interest rates are climbing once again. In fact they’ve doubled in the last 12 months. (According to Hawai‘i Business News, rates escalated from a national average of 3.22% in the first week of January to a high of 5.81% in the third week of June.) So the somewhat gleeful seller’s market has shifted, and folks are looking for creative ways to help move properties.
A higher interest rate can be bad news for potential buyers, particularly first-time homeowners—but it is not an impossible obstacle, especially with some help from a skilled Realtor. We have a ton of experience in seller’s markets and buyer’s markets, and we know a few ways to help negotiate not only the best price, but the best rate for your individual situation.
There are several ways to decrease mortgage rates. One you’ve probably heard of is buying “points.” A point is equal to 1% of the total loan; or $1,000 for every $100,000. Points are paid directly to the lender for a reduced interest rate over the life of the loan. It can be a terrific benefit, especially for those who plan to stay in the home for the long term. On the down side, it requires more cash up front, in addition to the down payment, closing costs and reserves.
Another way to help with the interest rate is called Interest Buy Down (IBD). Very similar to buying points, IBD is a temporary interest rate reduction. And it can be paid by the buyer, seller, lender, Realtor or the builder, especially in a new home development or subdivision.
Basically, a lump sum payment goes into an escrow account at closing. The borrower pays the lower interest, the “start rate,” and the IBD escrow account makes up the difference to meet the “note rate.” If the buyer re-finances, any leftover money can be applied to the principal.
My son just walked through the room and asked what I was writing. He said I lost him at “interest buy down.” LOL. If that’s how you feel, as we say in Hawai‘i, no shame! Hapuna Realty has the right kind of experience to provide you with advice on your options.
Let’s say you’ve found a gorgeous little tiny home on Hawai‘i Island. The asking price is 15,000 apples. Wait, this is Hawai‘i; let’s say 15,000 mangoes. You make a down payment of 20%, or 3,000 mangoes.
You go to the bank, and arrange a loan of 12,000 mangoes. You agree to pay the loan off over 10 years (120 months), and the bank charges you 3% interest, or 360 bananas per year. So, for the next 10 years, each month’s payment is 100 mangoes plus 3 bananas.
Your mango tree is doing great, but your banana tree is very small. You can only pay 1 banana per month.
You make arrangements with a friend to buy down your banana payment by 2 bananas per month for the first two years. This is only temporary until your tree starts producing more. The bank takes the 48 bananas (2 bananas x 24 months) and keeps them in the escrow freezer. Every month they take out 2 bananas and add it to your 1 banana plus 100 mangoes to make the full payment amount.
In two years, when the tree starts producing big bunches, you can pick up the 3-banana payment on your own. That would be called a 2-2 buydown. Your friend buys down the interest on your mangoes by 2 bananas for 2 years.
All silliness aside, there are real advantages to IBD. It helps buyers, especially first time buyers, consider a larger home. And, it works well for buyers who anticipate an increase in income in the next few years. David Cox, a sales manager and senior loan originator in Boulder, Colorado, explained in a September 2022 interview with the Washington Post.
“Interest Buy Down can be better than increasing the down payment or paying points to lower the interest rate. The buy down is a shorter break-even point,” Cox says. “For example, at current interest rates, a larger down payment will only impact the monthly payment by about $5.40 for every $1,000 or about $54 a month for an extra $10,000 down payment. For a 2-1 buy-down scenario in which the purchase price is $600,000 with 20 percent down and $10,000 is put toward the buy-down, the buyer’s payment would be reduced by $550 a month during the first year and $285 a month the second year.”
I don’t know about you, but all those numbers drive me bananas.
If you think IBD might be a good option, let the Hapuna Realty team help you determine the best deal for you and your new Hawai‘i home.