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4 Ways to Overcome Higher Interest Rate Mortgages
- Buy-Down Mortgages
A Buy-Down Mortgage offers temporary interest rate relief by lowering payments for the first few years of the loan. In a 2-1 buy-down, the interest rate is reduced by 2% in the first year and by 1% in the second year before settling into the full rate in the third year. A 3-2-1 buy-down extends this relief for three years, with 3%, 2%, and 1% reductions in each respective year.
The buy-down payment can be made by the homebuyer, seller, builder, or even the mortgage lender, and it’s designed to help make the mortgage more affordable early on. However, homebuyers should be aware that after the buy-down period ends, they will face a higher monthly payment at the full interest rate.
Buy-downs are typically available when purchasing or refinancing a primary residence or second home, but they are generally unavailable for investment properties or cash-out refinancing. Sellers and builders frequently offer buy-downs to make their properties more appealing by reducing the buyer’s initial payments.
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Let’s see how this works for two scenarios:
- $250,000 Purchase with a 6.5% Interest Rate
2-1 Buy-Down:
- Year 1:$1,264 at 4.5%
- Year 2:$1,419 at 5.5%
- Year 3 onward:$1,580 at 6.5%
- Buy-Down:
- Year 1:$1,132 at 3.5%
- Year 2:$1,264 at 4.5%
- Year 3:$1,419 at 5.5%
- Year 4 onward:$1,580 at 6.5%
- $750,000 Purchase with a 6.5% Interest Rate
2-1 Buy-Down:
- Year 1:$3,792 at 4.5%
- Year 2:$4,257 at 5.5%
- Year 3 onward:$4,739 at 6.5%
- Buy-Down:
- Year 1:$3,396 at 3.5%
- Year 2:$3,792 at 4.5%
- Year 3:$4,257 at 5.5%
- Year 4 onward:$4,739 at 6.5%
Key Takeaway: Buy-downs provide immediate payment relief and can be funded by the buyer, seller, builder, or lender. However, buyers must be prepared for higher monthly payments once the buy-down period ends. This option is typically available for primary or secondary residences, not for investment properties.
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- Paying Discount Points
Discount points are another way to lower interest rates. Buyers pay a lump sum at closing to reduce their mortgage rate for the life of the loan. Each discount point costs 1% of the loan amount and generally reduces the rate by 0.125% to 0.25%.
Buyers can pay for discount points themselves or negotiate for the seller or builder to cover the cost, especially in a buyer’s market or when purchasing new construction.
Let’s see the impact on a $250,000 and $750,000 purchase:
- $250,000 Purchase at 6.5% with 1 Discount Point (reducing rate by 0.25%)
- Without points:$1,580 monthly payment
- With points (6.25% rate):$1,538 monthly payment
- Savings per month:$42
- Total cost of points:$2,500
- $750,000 Purchase at 6.5% with 1 Discount Point (reducing rate by 0.25%)
- Without points:$4,739 monthly payment
- With points (6.25% rate):$4,615 monthly payment
- Savings per month:$124
- Total cost of points:$7,500
Key Takeaway: Discount points can lock in long-term savings, especially for buyers who plan to stay in the home for many years. Buyers can also negotiate for sellers or builders to cover these costs.
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- Adjustable-Rate Mortgages (ARMs)
An Adjustable-Rate Mortgage (ARM) offers a low fixed interest rate for an initial period—usually 5, 7, or 10 years—before adjusting annually based on market conditions.
Let’s compare a 5/1 ARM to a 30-year fixed mortgage:
- $250,000 Purchase with a 6.5% Fixed Rate vs. a 5/1 ARM at 5.25% for First 5 Years
- 30-Year Fixed (6.5%):$1,580 monthly payment
- 5/1 ARM (5.25% fixed for 5 years):$1,476 monthly payment
- Savings per month (initial 5 years):$104
- $750,000 Purchase with a 6.5% Fixed Rate vs. a 5/1 ARM at 5.25% for First 5 Years
- 30-Year Fixed (6.5%):$4,739 monthly payment
- 5/1 ARM (5.25% fixed for 5 years):$4,428 monthly payment
- Savings per month (initial 5 years):$311
Key Takeaway: ARMs offer significant savings during the fixed-rate period, making them a good option for buyers who plan to sell or refinance before the adjustable period begins.
- New Construction Incentives
Builders use rate buydowns to make new homes more appealing and affordable in today’s market. For example:
- M/I Homes offers a 2-1 temporary rate buydown on select homes, bringing the first-year rate down to 1.875% for FHA loans, increasing to 2.875% in the second year and 3.875% from year three onward. This is available for homes closing by the end of 2024
- National Builders contribute 5% to 6% of the home purchase price to lower mortgage rates by one or two points, often reducing the interest rate to 5.0% from a market rate of 6.5%. Another standard option is the 2-1 buydown, which can drop the rate to 4.5% in the first year and 5.5% in the second year before it returns to the full rate
- Century Communities has been offering buydowns that bring rates to 5.99%. The cost of the buydown can range from 3% to 5% of the home’s sales price, depending on the underlying mortgage rate and loan amount(
These incentives make new construction more attractive by reducing early monthly payments, giving buyers an easier path to homeownership in a high-rate environment.
- Conclusion
These strategies—buy-downs, discount points, adjustable-rate mortgages, and new construction incentives—allow buyers to navigate today’s higher interest rate environment. Whether the cost is covered by the buyer, seller, builder, or lender, each option offers a way to reduce mortgage payments in the short or long term. Educating your buyers on these options can help them stay engaged in the market and find a solution that works for them.
If you want to ‘Articulate your value’ to your buyer clients, THIS is a great way to do it…during your Buyer Presentation!
