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A Seller's Strategy When Interest Rates Are Falling

2001 will be remembered as the year interest rates fell to 30 year lows, serving as a lesson for all of us. As the rates declined, home affordability increased, bringing new buyers into the market and upgrading the buying power of those buyers already shopping. Home sellers rejoiced - 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):

$75,000 mortgage at 7%
25 year amortization

Buy down to 6%

Buy down to 5%

For 24 months

$1,337*

$2,673*

For 12 months

$698*

$1,397*

*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.