The Rate Buydown vs. the Price Cut
A buyer is approved for a $400,000, 30-year fixed loan at 6.75% with 20% down on a $500,000 home. The seller offers either (A) a 2-1 temporary buydown funded by the seller, or (B) a $15,000 price reduction. Under option A the buyer's rate is 4.75% in year 1 and 5.75% in year 2, then 6.75%. The buyer plans to stay about 4 years and has limited cash. The lender's closing costs are $9,000 either way, and the buyer's monthly principal-and-interest payment at 6.75% on $400,000 is about $2,594. The buyer asks which option is better and whether the buydown helps with the down payment.
1. Compare the two options over the buyer's expected 4-year horizon.
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Option A - 2-1 buydown: The rate is bought down for two years only. Approximate first-year payment at 4.75% on $400,000 is about $2,086; second-year at 5.75% is about $2,334; years 3–4 return to $2,594. Savings versus the note rate: year 1 ≈ $508/mo × 12 ≈ $6,096; year 2 ≈ $260/mo × 12 ≈ $3,120; total ≈ $9,216 over two years. Years 3–4: no savings. The seller typically funds the buydown by depositing the subsidy in escrow, which the lender releases over time.
Option B - $15,000 price reduction: The loan drops to $388,000 (80% of $485,000). At 6.75%, payment is roughly $2,516 - about $78/month less, or about $3,744 over 4 years in payment savings, plus a lower balance and lower interest over the life of the loan.
On pure 4-year cash flow, the buydown looks larger (~$9,200 vs ~$3,700). But the buydown is temporary and the buyer still owes $400,000 at 6.75% in year 3. The price cut permanently lowers principal. The buydown also does not reduce the down payment - it is a payment subsidy, not equity, and it does not help the buyer qualify beyond the lender's underwriting treatment.
2. What underwriting and disclosure issues should the buyer's agent flag?
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- Qualification: Lenders underwrite temporary buydowns using the note rate (6.75%) in most cases, so the buydown may not increase the buyer's qualifying amount. Confirm the lender's treatment.
- Escrow funding: The seller must actually fund the subsidy at closing; if the deal falls through or the seller refuses, the buyer loses the benefit. Get it written into the contract and the closing statement.
- Disclosure: The buydown must be disclosed as a seller concession; it affects the sales price reported and may affect appraisal comparables. If the price is inflated to fund the buydown, the appraisal could come in low.
- Refinance risk: If rates fall, the buyer may refinance and forfeit remaining buydown funds - check whether unused escrow is refundable.
- Cash constraints: With limited cash, the buyer should compare total cash to close: the buydown may keep more cash in the buyer's pocket, while the price cut reduces the loan but not closing costs.
Recommendation: model both with the lender's actual numbers, confirm note-rate underwriting, and consider a permanent rate buydown or a hybrid if the buyer plans to stay past year 2.