Why is an Interest Rate Buydown one of the most creative win-win strategies in real estate investment?

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Answered by: Howard, An Expert in the Investing in Real Estate Category
A seller is most commonly tempted to lower his asking price to entice the buyer to act. We see this approach often in down markets as we are currently suffering. An experienced mortgage finance professional or a bit of research by the independent real estate investor will clearly demonstrate why an interest rate buydown is a much wiser tool and proves to be a win-win for both parties, as well as the community at large.

For example, if the original asking price for a property is $200,000, the monthly principal and interest payment would be $1,073/mo. If the seller reduces the price by $20,000, the new payment would be $966/mo. or a savings of $107/mo. Thus it would take the buyer approximately 15.5 years to capture the benefit of the seller's concession of $20,000. When statistics indicate that the average homeowner either moves or refinances every five years, one could argue that the likelihood of the buyer fully realizing the seller's price discount is unlikely.

Looking at the interest rate buydown example, we see a few immediate benefits. The buydown allows the seller to apply funds on the buyer's behalf to lower the initial interest rate -- typically for a period of the initial three years - by three points in year one, two points in year two and one point in the third year before going to the note rate in year four and for the remainder of the thirty year contract duration. The cost of this buydown would still allow the remainder of the $20,000 concession ($11,800) to lower the sales price to $188,200. In so doing, the buyer's monthly payment is $695/mo., in year one, $793/mo in year two and $898/mo in year three before changing to the final payment of $1010/mo for the duration of the contract.

In the bigger picture, the borrower's payment will be $44/month more for the duration of the contract with the buydown example.

Within the five year time frame in which most people either move or refinance, he will spend $528 more than with a simple $20,000 seller concession. But the true magic of the buydown strategy invaluable is that, the borrower with a 680 credit score qualifies at the buydown rate -- in this case --2%!!!

Thus he may be able to get into a property which he might otherwise not qualify for. Unlike the nightmarish scenarios of variable rate loans, the borrow knows exactly what his payments will be in years two, three and finally for the duration of the loan. There are no surprises and he is not at the mercy of the vagaries of interest rate fluctuations.

By adopting this strategy, the seller dramatically expands the population of potential buyers. While lowering the asking price by $20,000 and the concurrent monthly savings of $107 will admittedly qualify more buyers, the buydown strategy which lowers the payment by $378/mo will significantly increase the pool of potential buyers. As a tangential benefit to the community, the buydown allows the seller to avoid discounting the sales price of his property thereby slowing the nationwide implosion of housing values which we are currently witnessing. Appraised values will stabilize as will tax revenues to local governments.

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