Mortgage Interest Rate Buydowns
Here is a common question often asked.
What is the difference between a mortgage buy down calculation and an Interest Rate Differential (IRD) calculation? The answer is, there is no difference. The only difference is in the terminology used and the explanation.
The calculations are rounded to the nearest dollar because the software has to use a trial and error method of iteration. If the calculations were to be to the penny it would take excessive time due to the increased iterations. Most people wont complain about a dollar difference on a $150,000 mortgage.
A mortgage buydown calculation:
Lets assume you are selling your house and you want to make it attractive by having a low interest rate on your assumable mortgage. Your current mortgage balance is $150,000 but the rate is 11% for the next three years. You want to buy it down to a 7% rate which makes the mortgage more attractive. Your lender wants $15,440 up front to continue on for the next three years at the lower rate of 7%. You don’t have the $15,440 so its added on to your outstanding balance. The mortgage balance for your new home buyer at the end of 3 years is exactly the same, $145,803 as if you left the balance at $150,000 and he assumed the 11% mortgage. All YOU really do is add the $15,440 onto the selling price of the house before you list it for sale.
An IRD calculation:
You took out a mortgage two years ago on a 5 year term and a rate of 11%. Your now two years into the term and three term rates are 7%. You ask your friendly lender what the penalty is to open your five year term and pay 7% for the next 36 months at the same monthly payment. Since most people don’t have $15,440 your friendly lender adds the $15,440 onto your balance and you continue on the same monthly payment s for 36 months. At the end of the 36 months your balance is the same and your lender got exactly the same return on your mortgage. You have not saved a penny. Your costs for the three years were the same as if you did nothing. That’s what the bank intended by using the IRD calculation. Can you now appreciate the advantage of having your own amortization software and also discounting software? No company to my knowledge in Canada and the USA offers DISCOUNTING software like amortization.com limited.