What if I told you that I could get you an interest rate that is 3% below what the current market rate is at no cost to you?
Sounds appealing and almost too good to be true right? Well, I can assure you it is and we are seeing our clients use this strategy all the time right now. Let’s dive in.
We have two loan products right now that we are working with as a real estate team, and they are helping our clients get below 3%. Market interest rates are currently at seven, and we’re getting our clients’ interest rates in the fours. I’d love to tell you all about the two loan products we’re using and the pros and cons of each to determine which might be a better fit for you.
My name is John Gluch. I’m the team leader of the Gluch Group. We’ve got real estate teams in San Diego, Las Vegas, and Phoenix, and we see hundreds of homes every year; many of those homes have loans attached to them as they’re not cash purchases.
So we’re in the thick of this, and interest rates were 3% not long ago, and now (as of the date of this recording), we are in the 7% range. That’s a gigantic shift, and we’ve been busy working on finding solutions for our clients to help them navigate this blow to purchasing power.
Two loan products with pros and cons:
So let me talk you through the high level and give you some recommendations.
3-2-1 Buydown Mortgage:
This is a loan product that allows you to artificially lower the interest rate for the first, second, and third years that you own the property. And here’s how it works: There’s an upfront payment, and that upfront payment pays down the payment for those years. So it pays down to a 3% discount in your first year.
So for our example, let’s say market rate right now is at 7%, so your first year is going to be 4%. In your second year, it’s going to go up by one percent to 5%. Your third year, it’s going to go up by one percent again to 6%, and then your fourth year, it’s going to be at the 7% rate. So for three years, you’re getting the benefit of that discount for an upfront payment.
But we have some secrets as to how to avoid you actually paying that fee. I’ll talk about those later in this blog.
Let me give you some specifics on those numbers. So let’s say it’s a $500,000 loan. I’m just going to give you these figures and the principle and interest, so I’m not factoring in taxes and insurance and all that. This is just what your payment is going to be. So on a $500,000 loan at 7% for four years, your payment should be $3,327. That’s a relatively high-interest rate compared to what we were getting years ago. So this buydown brings your payment all the way down to $2,387 in year one. That’s a gigantic difference! $940 difference per month for the first year. In the second year, your payment is going to go up to $2,684. The third year costs $ 2,998. And then the fourth year again is $3,327. So your payments are ratcheting up slowly but surely. As you can see this is a fantastic way to get your payment to be lower initially, but then, of course, gradually goes up over the next couple years.
So why would you do this? Or maybe more importantly why wouldn’t you do this? You know, eventually, the payment’s going to be what it is. What’s the benefit here?
Well first, we’re betting on the fact that interest rates are going to get better, and then at some point in the next three years, you’re going to be able to refinance out of this into a better loan product. This is the assumption that makes this program such a huge game changer, and heres why.
The likelihood is very, very strong that interest rates will get better. Because in every recession we’ve had as a country, the interest rates on loans have gone down during those recessions. And there are all kinds of reasons why that happens. But let’s just say, for the sake of simplicity in this blog, that it’s probably going to happen. It would be exceptionally unlikely and unusual for interest rates not to go down during recessions. And everyone, all the talking heads, the big voices, the smart people who figure this stuff out, say we are either in a recession or we’re headed toward one very quickly. I think that’s extremely likely.
So if you’re like me and you’re betting that we’re going to have a recession, as every other time interst rates have gone down, this isn’t a bad idea because it gets you into a nice low payment for a couple of years while you have this beautiful new home that you purchased. And you just refinance out. Now of course there’s a chance that that doesn’t happen and you eventually get to the full payment.
Well, the good news is that the underwriter, meaning the person at the bank who decides you can afford this loan, is going to underwrite you at full payment. They’re not. This isn’t 2005, when it was just like, “Well, you might be able to afford this.” Let’s give you the loan.
No, you’re going to have to be able to afford the full payment. They’re going to make sure that all your ratios work at that big full payment. You’ve got to be able to know that, worst case scenario, you’re sticking with this loan. Again, though, the likelihood is, of course, that it does go down. So that’s one pro, which is that of course, you get a lower payment in the first year, second year, and third year.
So, the next question is how does all this interest savings in the first 4 years get paid? Where does the money come from? Short answer is you, all the money that you saved you need to pay or “buydown” on the front end—the upfront payment, in this case that would be $22,927. So it would cost you roughly 23 grand to do this. Sounds like a lot of money no doubt, but one huge benefit to also consider here is that if you refinance in say year one, that money doesn’t just disappear. You can roll that forward into the refinance; you get the money back and don’t lose it.
How do you avoid paying that money?
You don’t want to pay for the upfront buydown payment if you don’t have to right? If you can get someone else to pay for it instead wouldn’t that be a huge win? The real estate market right now is pretty slow. Not every realtor is telling you what I’m telling you, which is, “Hey, we have options for you to get lower rates.” Because rates are so high, people are freaking out and they’re waiting for rates to go down to buy a house, so you don’t have much competition, which means you as a buyer walk on into any house that happens to be for sale and you’re kind of a big deal. Now, you know, a year ago they didn’t have the time of day for you because they had 20 offers. Well, now you’re in control.
And so, what can you do? Ask the seller to pay that $22,927! We are seeing this much more often. This is considered a seller’s concession. And this used to happen all the time. I’ve been doing this for 20 years, and for many years, this was a very common scenario. The seller would pay some of the fees, whether it was lender fees, commissions, title fees, or whatever. And that’s much more likely now because you don’t have near as much competition and it has shifted into a buyer controlled market. So it is not unlikely at all that we can get the seller to pay that some if not the entire fee for you.
Of course, that depends on how popular the property is and how they price it. If it’s a gorgeously remodeled house that they price 10% below market, you’re going to be fighting with other people. But that’s not happening very often right now. It’s a nice spot for you to be in and negotiate to get yourself a buydown that you didn’t pay for.
What are the cons? Of course, interest rates might not get better. You might not be able to refinance. You could potentially, if home values go down and you’re trying to refinance, find it tougher to refinance. You’re, in theory, paying more for the house because you’ve got the upfront fee that the seller’s paying. Yes, they’re paying for it, but could you have gotten a little better deal, possibly?
So there are some downsides, and of course, there’s the upfront payment. You’ve got to be ready for it. You’ve got to be able to make that increased payment as it goes up. So there are some downsides to this product, but I like it as an option. It’s absolutely worth taking a look at.
3-2-1 Buydown Pros:
- Lower Payment in year 1, 2, 3
- Use credit remaining if refi to buy down the loan (depends on the lender)
- Seller is paying for it if you can work it into the deal properly
- Likely lower rates in the future (every recession has had rates fall)
3-2-1 Buydown Cons:
- You are betting on being able to refinance out of this deal and if values fall that may not be possible
- Expensive IF you cant get the seller to pay it
- You are in theory paying more for the house so that you can structure this in the deal, if rates were not an issue you would take a lower price
- It would be wise to put a larger down payment on these so that if values are lower when rates drop buyer can still refinance
- Stepped up payment each year (people get used to what they are paying and it changes)
The second option, which I generally like better if it happens to be available (sometimes it is, sometimes it isn’t). And that is an adjustable-rate mortgage. So if you are either not going to stay in the house for very long or you are willing to take the bet that interest rates will get better, an Adjustable-Rate mortgage might be for you. I happen to have an adjustable-rate mortgage.
Here’s how those work: there are two numbers in front of them; they’re called an ARM, or an adjustable-rate mortgage. The first number is how long your rate has been fixed. So there are three one ARMs, five one ARMs, or seven one ARMs.
The first number three, five, or seven in those examples—is how long the rate is fixed. You have to check with your lender and compare these two products. But right now, we are seeing ARMs priced about 3% lower than a conventional mortgage with a fixed rate payment. So in our example, instead of seven, it’s four. That four on a three one arm is going to stick at four for three years, and then it’s going to adjust.
The first question is how often it adjusts. So every year thereafter it will adjust, and every ARM has a maximum. It can’t adjust by 10% in a year. They all have their maximums for how much they can adjust, typically 1% per year. And so you’re assuming that, in a three one ARM for example, you’ll get your first three years at 4%, then your fourth year goes up to 5%, the next year goes up to 6% in theory, and so on. Once again, you’re betting that rates will go down, you’ll be able to refinance into a better product, and there are varying lengths and degrees of these.
The nice thing about ARMS like this is that there are no upfront costs. So that $23,000 payment that you would get on a buydown, that doesn’t exist, which is fantastic. That’s a real pro for this option.
The downside is that the rate could get higher than on a buydown. So if you are stuck with this loan for whatever reason, because you can’t refinance into a lower payment or your equity goes down and you can’t refinance—the possibility of it getting higher than 7 % is very rare. Whereas, with the 3-2-1 buydown, it’s never going to get higher than the current rate. So these arms are a little bit riskier in that the upside of the rate could be higher The nice part of it is that there’s no upfront fee.
- could go down
- no upfront cost like a buy-down
- Depending on market conditions can be much lower interest rate than fixed rate
- Credit unions often best source for these
- could go way up
- Can be harder to find
- No guarantee you will sell or be able to refinance
Which one is better for you?
To recap, I like the arms better if you believe you’re going to be able to get an interest rate that’s lower in the future. If you know you’re not going to live in the house for 10 years, this still becomes a possibly interesting options, you just have to do the math to determine what year is the break even point, warning this gets particularly tedious.
It’s all about you and your circumstances, and that’s where you need a trusted advisor. You need to get a great real estate agent and a great lender. If you are interested in comparing these two products and seeing which one might be a better fit for you, Reach out. We can help advise you and give you all the numbers exactly as they would be today.
It’s going to take connecting with us or another professional in your area who knows the loan products because we have certain lenders we use for certain products and others. We’ve worked hard to shop the whole marketplace and find who are the best lenders, and that changes day to day in terms of who has what and what kind of availability.
Reach out to us, we would love to help you solve your specific loan problems, answer your questions, and make sure that you have the best possible advice moving forward. I hope this helps you wrap your head around how you, as a buyer, can have a real advantage in this marketplace by stepping in and purchasing properties. You have a much better interest rate than all the other people bidding, and that gives you a real competitive advantage to go out and get yourself a fantastic deal.