What is a 3-2-1 Interest Rate Buy Down?
With interest rates rising and then bouncing around like a yoyo, sellers and lenders have pulled an old tool out of the tool kit to help with affordability, but it’s not for the feint of heart. So, how does a 3-2-1 interest rate buy down work, and is it a successful tool that can be used when purchasing your next home?
The success of a 3-2-1 interest rate buy down hinges on the premise rates will decrease again, in the next three years. The 3-2-1 interest rate buy down is typically paid by the seller, as an incentive to encourage an interested buyer to move forward with a purchase, despite current interest rates creating an affordability challenge, either perceived or legitimate. The seller pays an up front fee (a typical gauge is 2.5% of the loan value, or $10,000 on a $400,000 loan). In exchange, the buyer’s interest rate is reduced by 3% in the first year of the loan, 2% in the second year, and 1% in the third year. The gamble is that rates will decrease, and the buyer can refinance, before year four begins, or the buyer’s income will have increased over the course of three years and the rate is no longer a challenge.
Adjustable Rate Mortgage vs 3-2-1 Interest Rate Buy Down
There is also the adjustable rate mortgage (ARM), which works similarly to a 3-2-1 interest rate buy down. Typically, the first few years of an ARM are at a fixed rate below the current rates of a 30 year fixed mortgage. Depending on the loan product, anywhere between year three and five, the rate adjusts to whatever the current market rate is. Again, the gamble is that rates will decrease, and the borrower can refinance to a fixed rate.
How do Rate Buy Downs Affect You?
Both scenarios can obviously be considered risky, but the good news is the borrowers are still being fully qualified for the loans, unlike the stated income, no documentation loans of the 2004-2008 era where buyers simply told a loan officer what their annual income was (and the loan officer just took them at their word), and they did not have to provide any documents verifying that they even had employment or sources of income.
The long term average interest rate is 7.75%. The all time high interest rate was in October of 1981 at 18.63%. I won’t age myself, but as a child, I do recall hearing adults around the dinner table complaining about this. Here’s where the challenge occurs, as recently as January of 2021, we had the all time interest low rate of 2.65%. It is easy to see why today’s average of 6.94% seems outrageous, when in fact, it’s still below average.
If you have any questions about interest rate buy downs, specifically in Arizona, and how they can affect your home buying process, or are looking to work with our team of trusted real estate agents, give us a call today and we will be happy to answer any questions and help you build a plan that fits your needs. Contact us today at 480-759-1576, or visit us at Cusickgroupre.com. We look forward to talking to you!