FHA loans are a popular government backed loan for consumer mortgage products. Even with rates at historic lows in 2010, consumers can buy down their rate to get them an even more affordable monthly payment. In addition, buying down the rate can help build equity faster and help net a higher profit when selling a few years down the line. Here are the 5 things that every consumer needs to know about FHA rate buy downs.
1. They work best with fixed rate mortgages
A fixed rate mortgage is the most desirable product, as payments will not fluctuate over and above what you will see in an upward swing for property taxes and home owner’s insurance each year. When considering buying down your rate, it is best to do it with fixed rate loans only.
2. They come in 2 flavors
Rate buy downs can come as either a permanent or a fluctuating buy down. With a permanent buy down, the lower rate never changes, fluctuates, or increases. On the other hand a 3-2-1 buy down means that the rate will be two points lower than current market rate for one year, one point lower for the subsequent year and finally matching up with market rates in the third year. It is important to note the difference, however, between a 3-2-1 buy down and an adjustable rate mortgage.
Adjustable rate mortgages will increase or decrease based on current market rates, not to exceed 5 percent of the original interest rate offering. For example, with an ARM, starting out at 3 percent APR, the rate can never go above 8 percent. With 3-2-1 buy downs, however, if the rate is 5 percent today, the first year you will pay a 3 percent interest rate, the second you will pay a 4 percent interest rate, and finally in the third year the rate will increase to 5 percent, but will not exceed 5 percent for the lifespan of the loan.
3. Years of ownership
Selecting either a temporary or permanent rate buy down should be based on the approximate amount of years you plan to live in that home. Buyers who anticipate living in a home for 5 years or less would do better with a temporary buy down, versus a permanent buy down; simply because during the 2 years that the interest is lower, equity builds faster. Buyers anticipating staying in the same place for 5 years or more would benefit from a permanent rate buy down more so than a temporary one.
4. It will cost you
No one moves in to a home without expense. There are closing costs and pre-paid items for taxes and insurance due at closing, in addition to a down payment. The same is true for rate buy downs. The current buy down rate is $1,000 for each quarter of a point. Consumers wishing to buy down their rate by a full point should budget for an additional $4,000 at closing.
5. Sellers can buy down the rate for you.
FHA loans allow a seller to contribute 3 percent of the sales price to the buyer in a home sale. This 3 percent can be used toward closing costs directly, or can be structured to do a rate buy down. What’s my advice? Pay the closing costs out of pocket and use the concessions for a rate buy down. Take a $250,000 home for example, with the full 3 percent in seller concessions:
$250,000 x 3% = $7,500
Having $7,500 in concessions can buy the rate down by 2.75 percent. In other words, if an interest rate were set at 5 percent, buying the rate down with the seller concessions would put a buyer at an interest rate of 2.25 (on a permanent buy down) percent for the duration of a mortgage. On a 30-year loan, that is a total savings of nearly $140,000 in interest payments.