Exploring Rate Buy Downs in Mortgage Financing
Option one is rate buy downs. If you didn't know this already, there is an option where you can purchase what's called a "rate buy down" when you are getting the loan for your home. Essentially, what that means is that you can pay some upfront for points in order to temporarily reduce your mortgage rate. So if you don't know what a "point" is, it's basically just a one-time payment equivalent to about one percent of the loan amount.
For example, if you're trying to buy a $500,000 home with a seven percent interest rate and a $100,000 down payment, your loan amount is $400,000. That means that one point would be $4,000 and maybe you could reduce your interest rate by 0.25 percent with that one point. Now, it is possible to pay a ton of points and just get your mortgage rate down really low. But then you're going to have to pay a lot of points to get there.
Leveraging Seller-Paid Rate Buy Downs in Real Estate Negotiations
So typically, you can have the seller pay for these points as sort of a negotiation tool. For example, you could say, "Hey seller, I'll buy your property for $10,000 over asking but I want you to buy me two points in order to reduce my interest rate." So if you give the seller $10,000 over asking but then you get two points in return to lower your interest rate, you might have paid $10,000 over asking but your monthly payments would actually be lower than if you bought the home for list price but then got zero points from the seller.
The first takeaway when it comes to rate buy downs is that you can have the seller pay for the points to reduce your interest rate. And one thing I'll quickly mention is that Builders right now for new construction homes are currently offering pretty steep rate buy downs. So I've seen some really new construction homes where Builders are offering 5.5 interest rates on their new construction homes as an incentive for buyers to buy their homes. And so basically, the builders are just giving a huge credit to the buyers to buy down their rates.
Understanding 1-0, 2-1, and 3-2-1 Buy Downs for Mortgage Savings
Now with the rate buy down option, there are three special options you might want to consider: number one is the 1-0 buy down, number two is the two-one buy down, and then number three is the three-two-one buy down. And all three options work very similarly. Basically, with a three-two-one buy down, you'd be paying a good amount of points upfront so that you can reduce your interest rate by three percent in the first year of ownership.
So that means your year one interest rate would be somewhere in the ballpark of four percent because right now the average thirty year is seven percent. In the second year of ownership, your interest rate would be two percent lower which is around five percent. And then finally, the third year, your interest rate would be only one percent lower than the current interest rate which is seven percent. So in year four, you now revert back down to the regular interest rate of seven percent. That's how the three-two-one buy down works.
Understanding 1-0, 2-1, and 3-2-1 Buy Downs for Mortgage Savings
And probably figure out how the two-one buy down and the one-zero buy down works. So like I said, not clickbait, it is possible to get a four percent interest rate in today's market but remember that's just a temporary rate. What if I told you that you can actually get a four percent rate for the entire 30-year mortgage? And what if I told you you don't even need to involve a bank to get this loan? Well, that brings me to option number two which is seller financing.
If you keep up with the real estate investing world long enough, you know that there are certain topics within real estate investing that kind of become really popular one year but then kind of die out the next year. Well in my opinion, 2021-2022 was like the year of the short-term rental boom and Airbnb and all that kind of stuff but I think 2023 is really shaping up to be the year of seller financing mainly because of the high interest rate environment that we're in right now. Seller financing kind of helps to combat that or mitigate that.
So here's how it works. Seller financing is actually the simplest way to buy anything. It doesn't just apply to home and I've heard of people selling their cars with seller financing. The concept works like this. So imagine you bought a bike. Actually, let's say that you bought a cyber truck for a hundred thousand dollars in cash. Now I come to you and I say, "Hey look, I really like that cyber truck, I want to buy it but I only have twenty thousand dollars with me right now. So why don't I just give you a 20 down payment today and the rest of that eighty thousand dollars I'll pay it back to you but I'm gonna pay it back to you over the course of 30 years.
Understanding Seller Financing in Real Estate Transactions
Now in my example, replace the Cyber truck with a home and there you go, that's seller financing in a nutshell. And the reason why it's called seller financing is because the seller of the Cyber truck or in this case the home is essentially carrying the loan because as you might have noticed there is no Bank involved in this transaction it's just between me and the seller. And here's the kicker, because seller financing is between the seller and the buyer you can negotiate any terms you'd like but the seller has to agree to them.
So how do you get a four percent interest rate with seller financing? Well, it's pretty simple. You find somebody who's willing to sell you their home for a four percent interest rate. Without seller financing, I'd have to go to the bank to get an 80,000 loan and then take that eighty thousand dollars combined with my twenty thousand dollars and then go give the seller a hundred thousand dollars and pay them out completely but then I'd have to go turn around and pay the bank for that 80,000 loan that I got and the bank determines those interest rates it's not really that negotiable for me.
And so this is why seller financing has become one of the hottest topics in real estate investing today because you can potentially get a significantly lower interest rate if you find that right seller who's willing to sell it to you at that interest rate. Now when I first heard about this the first question I asked was well why doesn't every seller do that then right because they're earning interest on that money that you owe them but for this question it really comes down to when does the seller need that money.
If the seller decides to finance the Cyber truck to you using seller financing they don't get their eighty thousand dollars back today they would only get that twenty thousand dollars that you're down paying today but then they get the remaining eighty thousand dollars back over the course of 30 years with interest so they'd actually maybe make a hundred thousand dollars over the course of those 30 years but they had to wait 30 years to get that money whereas if the seller chooses not to use seller financing the buyer has to go to the bank to get a loan and then it completely buys out the seller so the seller now has that hundred thousand dollars back in his pocket today and he can use that hundred thousand dollars to go reinvest into something else today.
But there are two things you should understand about seller financing number one is most people want their money back today not over the course of 30 years with four percent interest rate and so it's pretty hard to find these type of sellers number two they usually have to own the Home Free and Clear in order to do this so typically you might see people who are retiring opting to sell their home with seller financing because they might not necessarily need the lump sum of profit sitting in their bank account maybe they do want to make an increased amount over the course of 30 years and just get a passive interest payment from you for the next 30 years.
Subject-To Deals for Lower Interest Rates and Seller Relief
So this option might sound great but there's one thing that I noticed about doing this when a seller agree so using seller financing at four percent they know that they are giving you an amazing rate and so what I've noticed is that they typically want you to give them a much higher purchase price because they are giving you such a deal on the interest rate. So all in all if you can find the right seller then seller financing can be a great option.
So, that brings me to the third option. Let's delve into this last possibility where some investors are actually finding interest rates in the two percent margin. It's quite astonishing considering the current market conditions. This final option is called "subject to." It's essential to note that while subject to and seller financing share similarities, they fall under the umbrella of creative finance.
With subject to, as a buyer, you essentially take over the mortgage payments from a seller. Let's say a seller bought a home for five hundred thousand dollars, and perhaps you utilized a VA loan where no down payment was required. However, due to market fluctuations, the home's value has depreciated to $470,000. Let's assume the sellers encounter financial hardship, such as job loss. In this scenario, they may struggle to sell their home because even if they manage to sell it, the proceeds won't cover the remaining loan balance. This is because they initially purchased the property with a zero percent down loan, leaving the loan balance at five hundred thousand dollars. Even if they were to sell the property for $470,000, they'd still have $30,000 left on their loan.
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This is where a subject-to buyer steps in. Typically, these buyers acquired their properties from sellers in 2021 or 2022 when interest rates were around 2.5 percent. The subject-to buyer proposes to the seller to take over the monthly payments, and in return, the seller transfers the title of the property to the buyer. Essentially, the subject-to buyer assumes the seller's position. This arrangement allows the seller to avoid foreclosure by handing over the property to the subject-to buyer, who then takes on the loan payments and gains possession of the home. The sellers can walk away without facing any repercussions or foreclosure. However, there's a drawback to this approach known as the "due on sale" clause, which I won't delve into here, but it's something you should definitely research if you're considering this strategy.
Evaluating Risks and Rewards for Savvy Real Estate Investors
Now, the primary issue I have with the subject-to approach is this: Why would you assume the position of a seller in such a scenario if you're the subject-to buyer? Essentially, you'd be taking on a $500,000 loan for a property worth only $470,000. The main advantage of this approach lies in the 2.5 percent interest rate that you inherit from the seller's existing loan. While holding onto the property, you may benefit as home prices appreciate and rents increase, eventually putting you in a favorable position with a 2.5 percent interest rate.
However, I typically don't recommend this strategy for beginners. Purchasing a property in negative equity solely for the purpose of securing a lower interest rate might not be the best option. It's essential to weigh the risks and benefits carefully. This approach is highly situational, and depending on your circumstances, it may or may not be suitable for you. While subject to can be an intriguing option, it's crucial to thoroughly evaluate its implications and suitability for your specific situation.