This blog contains some simple tips and advice from two regular guys. We're not accountants, financial advisors, or brokers, so follow, ignore, or discuss our ideas as you see fit.

Monday, January 26, 2009

3.875 on a 30 year fixed? What's the catch?

Posted By Paul

This weekend I was looking in the paper and saw several ads offering 3.875% on a 30 year fixed mortgage.

Having just refinanced I was confused...since I know that at their best the banks were offering 4.3% for a 30 year fixed. I figured there had to be a catch.

Well after some research it looks like there is a catch....sort of.

This is called a 'builder buy down' loan. As with all mortgages there are all different types of builder buy down loans, but the basic idea is this:

Are you familiar with mortgage points? The idea is that a bank will lower your mortgage rate if you are willing to pay some money up front as a fee (1 point just means once percent of the loan as a fee).

So let's say your bank is offering a 30 year fixed loan at 5%, and you need to borrow $200k to buy your house. When a bank says they offer you 4.5% with one point, it just means that you pay 1% of the mortgage up front as a fee to get the better rate. So in this case you'd have pay $2k in fees to get the 4.5% rate.

So basically a builder buy down mortgage is where the builder pays the point(s) for you. Think of it from the standpoint of the builder.

Let's say you just built a house that you are trying to sell for $500,000. Maybe by paying $10,000 (two points) you might be able to offer a rate that will entice buyers. From the standpoint of the builder:

1) It gets the house sold - if real estate prices are falling then the builder probably want to unload the house before the value falls any more. Paying the $10k now is probably a no brainer if the builder is worried that in a few months the house will be worth $490k or less anyway.

2) The house is sold at its list price - you see this in the fine print of these loans. This is important because often the builder isn't just trying to sell one house, but many houses all in the same neighborhood. By paying the $10k to get you the lower rate, the house still goes on record as selling for $500k. This means that it will hopefully keep the appraised values of the other homes in the neighborhood higher. If instead of giving the bank the $10k to get the better rate the builder instead just knocked it off the price, and sold it to you for $490k then now every other similar house in the neighborhood could be viewed as being worth $490k. If you are the builder and you have 20 of these homes to sell a hit like that is something you'd like to avoid. It's much better to pay the points to the bank and keep the value high. It's kind of a sneaky way to make the value of the home SEEM higher than it is, but from the builder's standpoint it's a smart move.

So overall, a builder buy down is a sign that the builder is REALLY motivated to sell the property (this is no surprise in today's market). IF you want to get the house anyway then there's no harm in taking advantage of it, just keep in mind that:

1) A builder buy down of a mortgage is a sign that waiting could result in lower house prices.

2) The higher appraised value of the house could affect your property taxes.

3) There are all kinds of builder buy down loans some only lower the rate temporarily (like for the first few years) so make sure you understand the terms of the loan.

There is a great detailed article on builder buy down loans here:

Builder Buy-Down at Lendingtree

I thought that the article did a great job of summarizing how to view these offers so I thought I would quote the final paragraph of the article here:

"A buy-down can be very attractive, but it shouldn’t be the decisive factor in your home purchase. Regardless of the buy-down, you should shop around, compare loan products from different lenders and take care not to overextend your ability to make your mortgage payments after the buy-down expires."

No comments: