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Builder buy-downs lower monthly mortgage payments

New-home builders typically are loath to reduce prices on new-built homes, but they may offer affordability-constrained buyers a variety of other financial incentives. One such incentive is the interest rate buy-down, in which the builder prepays a portion of the buyer’s early mortgage payments.

How does a buy-down work?
Perhaps the most common buy-down is the "3-2-1," which means the builder pays the lender an upfront fee to reduce the interest rate on your mortgage by 3 percent in the first year, 2 percent in the second year and 1 percent in the third year. After that, the buy-down would expire and your full mortgage payment would be due each month.

A builder that owns an affiliated mortgage company may offer you two buy-downs: a more attractive offer on a loan you obtain from the builder’s own company and a less attractive offer on a loan you obtain from another lender. Offers touted in new-home newspaper ads frequently involve a buy-down that’s available only if you finance your home purchase through the builder’s affiliated company.

Buy-down offers are negotiable in theory, but in the typical scenario, the builder presents an offer and the buyer either accepts or declines it without much, if any, negotiation.

Pros and cons of buy-downs
The chief advantage of a buy-down is the lower monthly mortgage payments in the early years of your home ownership, which may enable you to borrow more money or set aside savings for other needs.

A buy-down could be less advantageous than a lower home price, depending on the structure and value of the buy-down, the amount of the price reduction and the number of years that you intend to own your home. A lower price also could reduce your property taxes in some localities while a buy-down wouldn’t affect your property taxes.

Yet builders almost always prefer to offer a buy-down, not a price reduction because a lower price on one house might result in a lower appraised value of other houses the builder intends to sell later in the same community. Price reductions make it more difficult for the builder to increase prices while buy-downs help keep prices stable.

Buyers should shop around, buy-down or no
Builders offer buy-downs when interest rates present an affordability hurdle for buyers. The builder’s thinking is that the buy-down may entice the buyer to purchase a home or even a more expensive home. And the builder may be correct in that thinking.

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.

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