Rate buydown vs. closing costs vs. price reduction
Rate buydown vs. closing costs vs. price reduction.
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You're buying a home and negotiating with the seller when you ask for some concessions . The seller agrees to use some of their cash to sweeten the deal. Now, it's up to you to decide which concessions will give you the most value.
When a seller is willing to work with you to make a home more affordable, there are three main ways they can help you out.
First, they can give you a closing cost credit. This is up-front cash that covers some or all of your closing costs, reducing the amount you need to bring to the closing table. The credit might cover standard closing expenses, such as title insurance or appraisal fees, or it could go toward prepaying other costs at closing, like homeowners insurance premiums.
Second, the seller can pay for either a temporary or a permanent rate buydown . To temporarily buy down the interest rate, the seller deposits money in an escrow account, and the funds are used to cover some of your interest during the buydown period of one to three years. A permanent rate buydown involves paying the lender discount points at closing in exchange for permanently lowering the interest rate you're charged.
Finally, the seller can give you a price reduction. Lowering the purchase price of the home reduces the amount you have to borrow and can slightly lower your down payment and monthly mortgage payment.
Let's look at an example to see how these seller concessions compare. Suppose you're buying a $400,000 house with a 5% down payment and using a 30-year conventional loan at a 7% interest rate. The following table shows the math, using calculations from RMC Home Mortgage.
A closing cost credit lowers your up-front costs, but it does not affect the monthly payment or result in any additional savings over time. A permanent buydown reduces the monthly payment and may be worthwhile if you're going to keep the mortgage long-term. A 2-1 buydown reduces the monthly payment more significantly during the first year, but because the effect is short-lived, it's best if you plan to move or refinance. And a price reduction results in small decreases in both the down payment and the monthly payment.
Consider asking for a closing cost credit when you're having trouble coming up with enough cash to close. You can expect to pay 2% to 5% of the loan amount in closing costs, or $7,600 to $19,000 on a $380,000 loan. If you're not able to raise those funds from friends or family, a seller concession could be a good alternative.
A closing cost credit can also be helpful if you have other up-front expenses related to your move. For example, maybe the home needs minor repairs or upgrades, and you want to take care of them yourself rather than wait for the seller to get them done. You could negotiate a closing cost credit, then use the money you would have spent on closing costs to pay for the work on the home.
A rate buydown can be a worthwhile concession when interest rates are high.
If you're planning to keep your mortgage for several years, you might want a permanent buydown. This lowers the rate you pay for the life of the loan, and, as a result, your monthly payment is permanently lower. The savings can add up significantly over time.
A temporary rate buydown can give you an even larger reduction in your monthly payment, but it's only in effect for two or three years at most. Buyers might prefer this option if they're confident they can refinance to a better rate at the end of the buydown period, or if they don't plan to stay in the home very long.
"Maybe they're moving to another state, or they know they're going to be reassigned to another position within a short period of time. That [temporary] buydown then makes it very affordable," said Chris Parks, Sales Manager at Churchill Mortgage.
A price reduction can make sense when you're interested in reducing the total amount you borrow. Maybe you're just at the threshold of needing a jumbo loan, and you'd prefer to borrow a little less and get a conventional loan. Or maybe you have nearly enough saved for a 20% down payment to avoid paying private mortgage insurance, and a price reduction would bump up your down payment to 20% of the new loan amount.
Parks typically sees price reductions appeal to buyers who want to pay off their debt as soon as possible.
"That type of buyer tends to be very, very aggressively wanting to eliminate debt, and so those people will take advantage of the early payoff calculators that I give them and other things like that because they really want to eliminate debt quickly," Parks said.
You can ask to combine seller concessions, with the caveat that the value of the concessions can't be higher than the maximum for the type of loan you're taking out. The maximum concessions are a percentage of the purchase price, or in some cases, the appraised value.
