Yes. Lenders assess the
adequacy of income in terms of two ratios that have become standard in the
trade. The "housing expense ratio" is the sum of the monthly
mortgage payment including mortgage insurance, property taxes and hazard
insurance, divided by the borrower's monthly income. The "total
expense ratio" is the same except that the expenses also include the
borrower's existing debt service obligations. For each of their loan
programs, lenders set maximums for these ratios, e.g., 28% and 36%, which
are typical.
The maximum ratios are not
carved in stone but the burden of proof is on the borrower to make a
persuasive case for raising them. If there is no case for raising the
maximums, then the borrower�s only option is to reduce expenses, and
this requires some additional cash � either from the borrower or a third
party.
The cash can be used to repay
debt, but this reduces only the total expense ratio. It can also be used
to pay points, which reduces the interest rate and both ratios. Paying
more points to reduce the rate is sometimes called a "permanent
buydown" because the reduced payment holds for the life of the loan.
For this reason, the reduction in the payment is not very large.
Finally, the extra cash can
be used to fund a temporary buydown, which reduces the payments made by
the borrower using one of the formulas described below. Most temporary
buydowns are on fixed-rate mortgages, and the description below applies
only to them.
Temporary buydowns are the
most effective way to reduce both expense ratios because the payment
reduction is concentrated in the early years of the loan. The expense
ratios used to qualify the borrower are based on the reduced payment made
by the borrower in the first month.
To cover the shortfall
between the reduced payments made by the borrower and the regular payment
received by the lender, cash is withdrawn from a special escrow account
set up for that purpose. The total payment received by the lender,
consisting of the payment made by the borrower plus the withdrawal from
the escrow account, is exactly the same as it would be in the absence of
the buydown.
The table below illustrates
the three most common temporary buydowns. On a 3-2-1 buydown, the mortgage
payment in years one, two and three is calculated at rates 3%, 2% and 1%,
respectively, below the rate on the loan. On a 2-1 buydown, the payment in
years one and two is calculated at rates 2% and 1% below the loan rate.
And on a 1-0 buydown, the payment in year one is calculated at 1% below
the loan rate. The examples below assume a market interest rate of 7% on a
30-year fixed-rate mortgage of $100,000.
|
Payments
by Borrowers and Payments From Escrow Accounts on a $100,000
30Year 7% Mortgage With 3-2-1, 2-1 and 1-0 Temporary Buydowns
|
|
Year
|
Payment
Received by Lender
|
3-2-1
Buydown
|
2-1 Buydown
|
1-0 Buydown
|
|
Payment by
Borrower
|
Payment
From Escrow
|
Payment by
Borrower
|
Payment
From Escrow
|
Payment by
Borrower
|
Payment
From Escrow
|
|
1
|
$665.31
|
$477.42
|
$187.89
|
$536.83
|
$128.48
|
$599.56
|
$65.75
|
|
2
|
$665.31
|
536.83
|
128.48
|
599.56
|
65.75
|
665.31
|
0
|
|
3
|
$665.31
|
599.56
|
65.75
|
665.31
|
0
|
0
|
0
|
|
4-30
|
$665.31
|
665.31
|
0
|
0
|
0
|
0
|
0
|
|
Total
Escrow
|
|
$4586
|
|
$2331
|
|
$789
|
The 3-2-1 buydown involves
the largest reduction in the borrower�s payment in the first year, but
also requires the largest amount placed in escrow, as shown on the lowest
line.
You can easily see what a
temporary buydown can do for you by clicking on Mortgage
Payments With Temporary Buydowns: This calculator will allow you
to experiment with a variety of options that are available in the
marketplace. In general, you will want the smallest buydown you need to
qualify.
There are a few lenders who
will credit the borrower with interest on the buydown account. For
example, if you were credited with 4% interest on the 3-2-1 illustrated
above, the required deposit to the buydown account would fall from $4586
to $4369.
Some lenders including yours
not only do not pay interest on the buydown account, but dispense with the
account altogether, replacing it with additional points equal to the sum
of the buydown digits. That is, they charge an additional 6 points for a
3-2-1, 3 points for a 2-1, and 1 point for a 1-0. These charges exceed the
escrows required to make the buydown work, as shown in the table. Thus,
the required escrow on a 3-2-1 of $4586 at zero interest divided by the
$100,000 loan amount is 4.6%, not 6%. This is a ripoff. You should shop
for a lender who does not pad the charge in this way.
Copyright Jack Guttentag
2002
