With Interest Rates Soaring, Borrowers Turn to Buydown Agreements
As interest rates and property values remain at a steady high, borrowers are trending towards 2-1 temporary buydown agreements to keep their initial mortgage payments down. These borrowers are hopeful that they will be able to refinance in the future to bring their payments down permanently.
2-1 Temporary Buydown
A 2-1 temporary rate buydown is an agreement where the borrower pays a rate of 2% below the note rate for the first year of the loan, 1% below the note rate for the second year, and the note rate for the remainder of the loan period. The payment can take the form of mortgage points or a lump sum deposited into an escrow account with the lender to be applied monthly to reduce payments. Fannie Mae, Freddie Mac, and FHA guidelines require borrowers to qualify for their mortgage at the note rate, regardless of the buydown.
Advantages for the borrower are lower mortgage payments upfront. This allows the borrower a chance to refinance their loan after the initial two years in the hopes of getting a lower interest rate permanently. It also allows the borrower to save money upfront for home renovations or to pad their savings. Some borrowers may be expecting an income raise in the two years before the interest rate will increase to the note rate and will be enticed by the lower upfront payments.
There are possible drawbacks to a 2-1 buydown agreement from the borrower’s perspective. The agreement has a high upfront cost when funded by the borrower rather than the seller as a concession. The guaranteed payment increase can also be disadvantageous for borrowers who will have to constantly adjust to increasing mortgage payments throughout the first 3 years of the loan. Counting on an income increase or favorable refinance conditions can also be risky. Additionally, any issues with the escrow payments being sent will result in the lender being personally responsible for the amount due.
Buydown agreements can also be advantageous for the seller. Sellers can pay for the buydown as a concession, making it easier and faster for sellers to sell their home for a desirable price. This is especially helpful in a borrower’s market where there are more properties on the market than there are interested borrowers. If the buydown is seller paid, the stipulation must be included in the purchase and sale agreement.
Requirements for Lenders
Within a 2-1 temporary buydown transaction, lenders also face various requirements, depending on the investor. These requirements include, but are not limited to, utilization of a separate custodial account for buydown funds, stipulations regarding refundability and fund allocation, and adherence to guidelines for use of funds in the stance of past-due and foreclosure accounts.
In this current rate environment, the option for borrowers to be able to take advantage of this creative loan product is a strategic opportunity for all parties and helps keep the market evolving.
How can we help?
CLA is prepared to assist your institution. Our mortgage professionals can help you evaluate the impact this new rule has on your operations. We are here to know you and help you. Contact Us with any questions or to learn how we can assist your mortgage operations.
Elizabeth Dailey, JD, is a Regulatory Compliance Director with CLA. She is a graduate of the University of New Hampshire and earned her juris doctor at New England Law. She is admitted to the Massachusetts Bar.
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