Higher interest rates make it more difficult to buy a home, but there are some silver linings – and some workarounds – to make the current market a little easier on buyers.

The shiniest silver lining is that higher interest rates often mean less competition, slightly lower prices and eager sellers who might be more willing to consider negotiating and/or concessions than they would have been at this time last year.

An interesting workaround to consider is a 3-2-1 Buydown. This program temporarily lowers the interest rate on your mortgage by 3 percentage points the first year, 2 percentage points the second year and 1 percentage point the third year. After the third year, the mortgage reverts to the original rate. For example, using last week’s current 30% fixed rate of 6.5%, your first year’s interest rate would be 3.5%; your second year’s interest rate would be 4.5%; third year would be 5.5% and at the end of the third year, it would revert to the 6.5% rate which was the prevailing rate at the time the mortgage originated.

Ok but how does it REALLY work? And what are some of the pros and cons?

During an escrow, a seller can credit a buyer money that can be used to cover closing costs, repairs, appraisal gaps, etc. Sellers can also credit buyers money that is used to buy down the interest rate in this fashion. Let’s say, for example, during the negotiation, the seller agrees to credit the buyer $30k to buy down the rate. That money sits in an escrow account and during the next 3 years, the lender will tap into it in order to functionally buy down the rate. The money sits in an escrow account, but it ultimately belongs to the buyer, and any leftover funds at the end of the 3 years go back to the buyer.

The main benefit of this program is it reduces the monthly payment for an extended period. At the end of the 3 years, those buyers are still locked into the original prevailing rate, so it is important that buyers consider what that payment will be when they take advantage of this program. If the rates are higher at the end of the 3 years, they're ahead of the game. What if the rates come down during those 3 years?

If mortgage rates drop while a buyer is in the middle of a 3-2-1 buydown program, they can refinance to the new prevailing fixed rate. Should a rate decrease happen when the buyer still has a lot of that original $30k (from the example above) left, they can use that money to either cover closing costs on their re-fi, to buy down the new prevailing rate, or, depending on how much of that money is left: both! This is a huge potential advantage.

The main disadvantage is if a buyer uses this program to buy a home they won't be able to afford at the end of the 3 years at today's rate. You can't bank on the rates going down and a guaranteed refinance. So if you're considering this option, it's important to use these 3 years to increase your savings or get that promotion and raise that will allow you to comfortably make what will become your regular payment.

Currently, many financial experts think mortgage interest rates will come down a little bit, making a 3-2-1 buydown something that buyers should really consider. The workings of this are obviously a bit more complicated, so if you are interested in learning more about it, I am happy to connect you with my preferred mortgage lender.