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2001 will be remembered as the year interest rates fell to 30 year lows. As
the rates have declined, home affordability has increased bringing new buyers
into the market and upgrading the buying power of those buyers already
shopping. Home sellers are rejoicing - with one exception - the home seller
with a large existing mortgage.
Take the case of the seller who has a $75,000 - 7% mortgage on their $100,000
home. They only bought their home a year ago, but unexpectedly, their plans
changed and they are moving. The interest rate on their mortgage is higher than
current market rates so a buyer would rather arrange a new first mortgage than
assume the existing one. What's the problem with this? The seller probably has
to pay a penalty for early payout of the existing mortgage. They could avoid
that penalty if the buyer assumed their mortgage, but only an enticing price
reduction could persuade a buyer to assume this higher interest mortgage.
Payout penalty or price reduction: these are not attractive choices!
There is another option: the seller can buy down the interest rate. They ask
the mortgage company what it would cost to buy down the 7% rate to the current
rate. The mortgage company calculates the cost of lost interest and allows the
seller to pay it up front. Usually, this is substantially less than a payout
penalty or a price reduction. An added bonus for the buyer is the costs
associated with assuming a mortgage are typically less than arranging a new one.
The mortgage has now become a positive selling feature.
Here's an example of the cost* of buying down a 7% mortgage (calculated by
www.canadamortgage.com):
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$75,000
mortgage at 7%
25 year amortization
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Buy down to 6%
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Buy down to 5%
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For 24 months
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$1,337*
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$2,673*
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For 12 months
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$698*
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$1,397*
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*Other costs may
apply: administrative costs, legal fees
The cost of the buy down is determined by two factors: the interest rate
differential and the length of time that the rate will be reduced. The rule is:
the smaller the rate differential and the shorter the period of time for the
rate reduction, the less it costs to buy down the rate.
There are some considerations in this arrangement that the seller should
investigate. There may be other associated costs such as administrative fees
from the lender and legal fees. Exact costs should be confirmed in advance in
writing. Also, the seller should determine if they have any legal liability for
the mortgage after the buyer assumes it. As always, expert advice should be
obtained beforehand.
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