With interest rates hovering in the 8% range and home prices holding steady, many potential buyers feel squeezed out of this market. The high-interest rates are impacting everyone looking to make a move. From sellers who would like to upgrade and buy their next home to first-time home buyers who have been stretching to afford the home they desire, everyone is trying to figure out how to succeed in this market.
These challenges have spurred creativity with lenders, builders, and sellers to entice buyers and help move homes in the current environment. One way we’re seeing this is through temporary rate buydowns. Almost 60% of successful transactions closed last month reported seller concessions, and of those 40% of the concessions were used for rate buydowns.
What’s a rate buydown? At the highest level, a rate buydown is a temporary reduction in the interest rate. The cost of the buydown is calculated by the loan amount, interest rate, term, and type of buydown. The buydown is paid for with a seller credit and those funds are held in escrow and dispersed monthly to pay for the difference in rate. Unlike a permanent reduction obtained through buyer-paid discount points, if the buyer were to sell, refinance or pay off the mortgage before the end of the second year, the remaining escrow or buy-down funds are refunded to them or applied toward the payoff of their mortgage.
One of the more common offerings is a 2-1 buydown. The 2-1 buy down allows the market interest rate to be bought down by 2% the first year, by 1% the second year and then returns to the market rate for year three through the end of the mortgage term.
Here’s an example where a builder or seller has agreed to escrow $17,016 for the buyer to offset the cost of the current 8% market interest rate. In this example, the buyer will have an effective rate of 6% in year one, 7% in year two and 8% in years 3+.
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The escrow subsidies lower monthly mortgage payments for the first two years. Payments revert to the original rate for the loan term at year three. The number of years and the amount paid can be structured in many ways, while we’re seeing a lot of 2-1 buydowns, there are also 3-2-1 buydowns, 1-1-1 buydowns, and more. The options available vary by lender and whether you’re financing a conventional, FHA, VA, or Jumbo loan.
Advantages for Homebuyers — The most significant advantage of a mortgage buydown is the two-year reduction in monthly mortgage payments. This makes homeownership more affordable and eases the monthly financial burden on buyers at first. This strategy may be a real treat if rates drop in two years, as projected by Federal Reserve Economic Data (FRED) research, and the buyer refinances at a lower rate. Also note, that many lenders are offering “no-cost” refinances as part of their portfolio in anticipation of rates coming down and clients looking to lock into lower rates down the road.
Advantages for Sellers — Offering a mortgage buydown option can make a property more attractive to potential buyers. It can set your listing apart in a competitive market and make a quicker sale. Sellers may have more leverage in negotiating sales price and other terms, as it sweetens the deal for buyers as they will be better off with a concession for a rate buydown than they will be paying a reduced purchase price.
So, trick or treat? Ultimately, the buyer always pays. There is no free lunch, free shipping, or bags fly free. The buyer is paying for the home, and for the seller to subsidize the financing. The advantage for the buyer is that the subsidy amount is rolled into their overall financing cost and does not come out of their pocket during the initial years of the loan.
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Michelle Fitzgerald
Real Estate Broker, Realtor®
email: michelle@michellesellsdenver.com
Instagram: https://www.instagram.com/michelle_sellsdenver/