How To Get 2% Off Your Mortgage Rate

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3:55If you're all caught up on your money rehab, you know that the Fed cut interest rates. And you also know that this rate cut isn't going to affect mortgages for a hot minute. So if you're in the market for a new home, you might be gigging yourself for not buying a house in 2020 when rates were on the floor. But you don't have to because I do have some good news. Even though the average mortgage rate is around 6.2 % right now, there is a way to get a 4.2 % interest rate. It is called a 2-1 buy-down. This is a type of mortgage financing where the interest rate on your mortgage is temporarily reduced for the first two years of the loan.

4:30It's called a 2-1 buy-down because the rate is reduced by 2 % in the first year and by 1 % in the second year. And then in year three, it returns to the full permanent rate and stays there for the remainder of the loan. Or at least it can. But let's put a pin in that one for right now. Here's basically how it works. Let's say you get a 30-year fixed rate mortgage with an interest rate of 6 % to keep it easy. With a 2-1 buy down, in year one, your interest rate is reduced by 2%. So you're paying as if your rate was 4%. In year two, your interest rate goes up by 1%. So now you're paying as if your rate was 5%.

5:07And then in year three through 30, your interest rate goes back to the full 6%, and that's where it stays for the rest of the loan. So how much will that save you? Well, let's say you're buying a$400 ,000 home with a 6 % interest rate and you put 20 % down. That leaves you with a$320 ,000 mortgage. With a 2-1 buy-down, your monthly payment would be about$1 ,919. Without a buy-down, your monthly payment would be around$1 ,900. With a 2-1 buy-down in the first year, thanks to that 2 % interest rate discount, your monthly payment would drop to around$1 ,500. That's nearly$400 in savings a month, or around$4 ,700 in savings a year.

5:50And then in year two, with a 1 % rate reduction, your payment would be around$1 ,700. That's still about$200 less than your full payment, saving you over$2 ,300 a year. So you'd save nearly$7 ,000 in monthly payments. That is a pretty decent cushion while you're settling into your new home. Let's double click, though, on those savings, because this isn't just a magic trick where the$7 ,000 you saved in the last example just vanishes into thin air. Someone has to pay that$7 ,000. It's just not going to be you. The cost of a 2-1 buy-down is typically paid up front, and it's usually paid for by the seller or the builder.

6:29So essentially, the seller or the buyer is giving you a discount. Why would they want to do that? Well, if the real estate market is competitive or the seller is eager to close, they might offer to cover the cost of the buy-down as an incentive for you to buy the home. In fact, sellers often use this marketing tool in times of high interest rates to make properties more attractive. Or if you're buying a new construction home, the builder might cover the cost to make it easier for buyers to afford the home, especially if interest rates are higher than they've been in recent years. Builders basically want to move inventory, so this can be a win-win.

7:03Either way, ultimately, you will be asking for a discount on what you pay for the house. So you might be thinking to yourself, why would I do this instead of just asking for a discount on the purchase price? If I'm ultimately saving$7 ,000, why wouldn't I just ask for a$7 ,000 reduction on the purchase price? The answer is, if you're trying to save money in the first year of home ownership because you know you're going to be spending money on one-time purchases like furniture and home renovations, a 2-1 buy-down might be the best move for you. Let's follow the money trail more closely. And just a heads up, I'm going to throw a lot of numbers at you so my quant friends will really enjoy every single delicious data point here.

7:40But for my non-numbers-oriented money rehabbers, I'm going to give you a top-level summary at the end of all the numbers trails, so don't worry. Using our same example of a$400 ,000 home, what happens if you just ask for a$7 ,000 off the sale price of the house instead of asking for that 2-1 buy down. Well, that would mean that the house is now priced at$393 ,000 and your 20 % down payment would be$78 ,600, which is less than the$80 ,000 it would take to pay 20 % of a$400 ,000 home. So that's$1 ,400 of savings right there just by asking for money off the purchase price. However, here's where the discounted purchase price loses its advantage.

8:23The monthly payment for a mortgage on the discounted home would be$1 ,885. But with a 2-1 buy-down, the monthly payment in the first year is$1 ,528. When all is said and done, if you ask for a$7 ,000 discount off the purchase price of the home, you'll end up spending about$101 ,220 after the first year when you factor in the down payment and the monthly payments. With a 2-1 buy-down, you'll spend a total of$98 ,336 in the first year. So you net spend less in the first year by doing it this way. And I should say this can all change depending on what interest rate you get. So you will need to crunch the numbers to determine the best way you can save the most in your first year.

9:07If you do a 2-1 buy down, you have to remember though that this is temporary. You're not going to get a discounted rate on your mortgage forever. You might be thinking, why would I do this? Isn't it just kicking the can down the road? Well, a 2-1 buy-down can be a smart strategy if it's used in the right situation. Here are four reasons why it could be a great fit. Number one, lower payments at the start. The big appeal of a 2-1 buy-down is that it gives you breathing room in the early years of your mortgage. Maybe you've stretched your budget to get your dream home or you're expecting your income to increase in the next couple of years.

9:41The lower payments can help you ease into homeownership without feeling strapped out of the gate. Number two, you're expecting a financial windfall. If you know you've got more income coming your way, whether it's a salary increase, a business venture you're working on, or even an inheritance, you might prefer to have lower payments now when cash is tighter and be prepared for higher payments later when you'll have more financial flexibility. Number three, a hot seller's market. If a seller is eager to close a deal, but interest rates are really high, making buyers nervous, they might offer to cover the cost of the buy down to sweeten that deal.

10:14And that is pretty sweet. And number four, and this is a big one. You expect interest rates to continue to go down and you're planning on refinancing. The Fed is planning on lowering interest rates. So if all goes according to plan, the Fed funds rate will be lower in three years than it is now. And if that's the case, then mortgage rates will likely also follow and the refinancing stars will align. However, there is a chance that JPAL will not get this interest rate choreography just right and inflation will pick back up again and interest rates will either stay the same or maybe even go up again.

10:47So you should think about refinancing as a perk and not a guarantee. Okay, so let's recap the pros and the cons. The biggest pro is the lower initial payments. You get lower payments when you need them most at the start of homeownership, where you might be adjusting to all of these new expenses. If you know your financial situation will improve in a few years or the economy will improve in a few years, the 2-1 buy-down gives you time to grow into your mortgage. But let's really look at the cons with both eyes wide open. The biggie is that you'll need to be prepared for your mortgage payments to go up in year three.

11:22If your budget is already tight, this increase could be tough to handle unless you've planned for it. Banking on being able to refinance at a lower rate is not a smart strategy straight up. So if you're asking yourself, despite all these pros and cons, is a 2-1 buy down a good idea for you? Here are a few questions to ask yourself. Can I afford the full payment in year three? Make sure you're not stretching yourself too thin by thinking that the lower payments in year one and year two will last forever. If you can comfortably afford the payment when the full interest rate kicks in, you're in a pretty good spot.

11:55Will my income increase in the next two years? Well, if you're expecting a salary bump or more income in the near future, the 2-1 buy down gives you some time to grow into those higher payments. And can I get the seller or the builder to pay? This is the dream scenario. If you can get the buy down paid for by someone else, it is a great way to lower your costs in the first couple of years without it impacting your long-term financial picture. For today's tip, you can take straight to the bank. You can also pay for the buy down yourself. This would typically be done by putting extra money into the mortgage at closing, similar to buying down points to get lower interest rates, which I'll talk about in a big old mortgage episode coming up next week.

12:35Just remember, the cost of the buy-down needs to make sense when compared to how much you're saving in the first two years. So net-net, do the math, please. Money Rehab is a production of Money News Network. I'm your host, Nicole Lappin. Money Rehab's executive producer is Morgan Lavoie. Our researcher is Emily Holmes. Do you need some Money Rehab? And let's be honest, we all do. So email us your money questions, moneyrehab at moneynewsnetwork.com to potentially have your questions answered on the show or even have a one-on-one intervention with me. And follow us on Instagram at moneynews and TikTok at moneynewsnetwork for exclusive video content.

13:14And lastly, thank you. No, seriously, thank you. Thank you for listening and for investing in yourself, which is the most important investment you can make.

13:29Thank you.