People are obsessed with mortgage rates. It makes sense, of course. You feel like you’re committing to a lifetime of a particular monthly expense. 

It can really work to your disadvantage. And that’s what I want to write about here. You can get so blinded—or tempted—by a low mortgage rate, that you actually end up not saving money at all! 

This post is a little more math-wonky than normal, so I’ll do my best to walk you through it.

The Buy Down

When mortgage rates were at three percent, no one prioritized getting an even lower rate. It was already awesome! But when rates get to seven percent, the situation changes. Enter the “buy down.” This is when a lender gives a borrower the opportunity to essentially pre-pay the mortgage interest. 

The easiest way to think about it is like this: If you want to lower your mortgage rate from 7% to 6%, the bank will sometimes allow you to pre-pay 1% of the full amount at closing. It could cost you 0.25% of the mortgage amount to save 0.25% off the mortgage rate, but the lender might even give you a small discount to pay so much towards the buy down. What happens? The bank makes its money today, and you get a lower rate. Over enough time, this pre payment can work to your advantage. 

The Hypothetical

Which of these options would you choose? 

Option 1:

• Asking price: $2,000,000
• Mortgage Rate: 7%
• Downpayment: 20% ($1.6mm mortgage)
• Monthly Cost: $10,645

Option 2:

• Asking price: $2,218,750
• Mortgage Rate: 6%
• Downpayment: 20% ($1.775mm mortgage)
• Monthly Cost: $10,642

The monthly costs are equivalent, right? Yes, but the sale prices are very different. Everyone would probably want to spend less if they could, and then refinance later. At least that would be the advice I’d give my buyers. 

The only problem? These buyers didn’t know that Option One was even available, because we weren’t representing them. We were working for a seller. And we pitched them on the idea of buying down the mortgage rate FOR THEIR BUYER. I’ll explain.

The Pitch

The seller’s apartment might have been worth $2.25mm in another market, but it was worth much less—approximately $2mm. However, we had the buy-down in our backpocket. Our idea: Market the unit at the $2.25mm, and offer a buy-down of the rate, from 7% to 6%. The old closed sales in the building were showing the higher number. So marketing at $2,250,000 didn’t seem crazy. 

We were recommending the seller take Option Two that you see above:

• The sellers would pay 4% of the mortgaged amount ($71,000) to “buy down the rate” from 7% to 6%. We would market the property with the buy-down.
• Not including other closing costs, the seller would net $2,250,000 – $71,000 =  $2,179,000

If they went the route of marketing it at market value, what would have happened? The apartment would sell for $2,000,000. That’s a difference of $179,000 (again, before other closing costs). Even if the bank wanted to charge them 10% of the full mortgage ($177,500), they still would have been $72,500 ahead!

What did happen? The property sold for just under the asking price, a little over $2.2mm. The buyers were happy. And our sellers were very happy. Because the buyers didn’t do the math.

What Could The Buyers Have Done? 

They could have bought the rate down themselves. Here’s what could have happened with Option One:

• The buyers could have negotiated a lower purchase price. Say, approximately  $2,000,000
• The buyer would have a market mortgage rate of 7%, which they would then buy down for $64,000 (20% of $2mm is $400,000, meaning a mortgage of $1,600,000. 4% of this it $16,000 x 4, or $64,000)
• Another great feature: The buyer has a smaller mortgage if she chooses to refinance, which they’d do as soon as rates go down. 
• Their overall cost was $2,200,000. With Option Two, their overall cost would have been $2,064,000. The buyer would have saved $136,000!

The Takeaway

You have to think bigger. You have to think beyond mortgage rates. You have to think beyond today. You have to keep your wits about you. And that’s how we help buyers. In this case, these buyers needed stronger guidance. 

That’s what our system of Visionary Brokerage is all about.