Monday October 29, 2018 by The Mettle Group
A seller paid interest rate reduction or buy down is 300% more effective than a price reduction and I can prove it. What’s happening right now is our clients are getting sticker shock because not only have home prices gone up but interest rates have moved up. In Utah, we’ve seen appreciation rates in the double digits and we’ve seen interest rates increase by about 1.25% over the last year, causing clients to pause at the monthly payment.
What do we do? Do we move those clients to a lower price point? Or do we employ a more intellectual type solution? Well let me introduce you to the buy down strategy. I want to show you a couple of charts to prove my point and then encourage you to reach out to me if you have any questions.
The first chart I’m going to show you down below, sets the table with four different scenarios. Starting in the left, you’ll notice the 30 year market rate. This is a scenario as of what it would look like today with a $400,000 purchase price. Let’s say this client is moving a good amount of equity so he’s doing a $300,000 loan, market rate at five and a quarter with no buy down. He’s got a payment around 1,939 bucks, getting pretty close to 2,000. Might make this client a little nervous.
Let’s talk about the buy down strategy which is the second column. Let’s say instead of beating that seller up for a price reduction, you ask them to do a 3% of the loan amount or $9,000 concession towards the buyer’s closing cost. We then use that concession to buy down the client’s interest rate, which we can drop 3/4 of a percent below four and half percent in interest rate which is about what that client was probably anticipating. That yields the client a savings of about a $140 per month.
Now let me show you one other strategy. If the client might be in the home less than 10 years, we also like to show them the 10/1 arm which looks really attractive right now with interest rates below 4%. And that drops that payment down to 1,672. Getting a lot closer to that 1,500 mark that they might have been hoping for.
Now, here’s where the magic is with this strategy. And if you go to the very final column, you will see that in order to get that same payment, let’s say they wanted a payment around 1,800 bucks, you would need to reduce the price, have the seller reduce down to 370,000 or find a property priced at 370,000 in order to yield your client at today’s interest rates, an $1,800 payment. Think that through. It’s either $9,000 with a buy down strategy or a $30,000 reduction in price. Which would a seller rather pay? Which is more likely to benefit the buyer?
Now, let me show you how this works over the long term. Let’s take a look over the next 10 years. Which of these strategies is going to allow the buyer to pay the least amount of interest? Well, over 10 years, you can see without a buy down strategy, you’re paying $144,000 in interest. With the buy down strategy, you pay a $122,000 in interest. You’re saving the client $22,000 over 10 years with this buy down strategy.
Now if you move all the way to the right, you’re going to notice that the price reduction, saving that client a $30,000 on the price reduction, they still pay more interest on that loan. How is that? Well, it’s because how amortization tables work. When you have a higher interest rate on a loan, you’re paying less towards principle which means you’re going to pay more towards interest even if your loan amount is $30,000 lower. Most people don’t understand that.
The next thing I want to show you is the amount of principle paid in 10 years. Same thought process here again. The buy down strategy has you paying almost $60,000 in principle reduction where in the far column to the right, the price reduction has you only paying $50,000 in principle reduction. Less interest, more towards principle, guess what happens to your total net worth, your equity in the property? You guessed it. The buy down strategy after 10 years, has the client’s equity in the property at 351,000, almost 352,000 as compared to the price reduction would only have their equity at 320,000.
This is a critical concept and strategy for you to understand. If you are a referral based realtor that feels you have a fiduciary duty to your clients to guide and advise them, we’d love to tell you a little bit more about how this buy down strategy works. How we employ it and how we educate our clients. We’d love to hear from you. Feel free to message us or give us a call.