As the US housing market continues to reel from spiked mortgage rates, buyers and sellers are increasingly looking for mortgage rate buydowns.
Buying mortgage rates can vary, but with a 2-1 rate buydown, the seller always pays to lower the buyer’s rate by 2 percentage points in the first year and 1 percentage point in the second year. In the third year, the buyer pays the note rate.
“[Buyers] save a lot of money in the first year and in the second year, even if they stay with the record level, they have the first two years to manage their finances, “Evan Tando, CEO and Broker of Record at ANR Finance + Real Estate, told fortune.
If a buyer buys a $600,000 home and takes out a $570,000 loan at a fixed rate of 6%, the monthly payment would be about $3,417. But with a 2-1 mortgage rate buydown, for the first year, the monthly payment will be around $2,721 (at a 4% rate). And for the second year, the monthly payment will be $3,060 (at a rate of 5%). Therefore, the buyer saves $8,354 in the first year and about $4,291 in the second year.
“It’s always been available, but no one has used it in the last few years because it’s really unnecessary, especially in 2020 and 2021,” Tando said. “But when we get 7% [mortgage rates] in October, we really need to figure out how to get people in the house and make it affordable.
But there are a few things to note: the buyer must be fully qualified (qualifications can vary depending on the type of loan), and the money doesn’t just go straight to your pocket. However, it is put into an escrow account, which actually works in the buyer’s favor if the rate goes down. So let the rates go down, then the buyer can choose to refinance and lock in a lower rate, but the money left in the escrow account is still the buyer’s and can be used as credit.
“The seller pays this fee,” Tando said fortune. “And that’s money you’re not going to lose, even if you pay it back.”
So, you might be wondering what the seller bought, considering in the above scenario that the price is more than $12,600? Yes, they are selling properties in this collapsed housing market, which is in correction mode due to lack of affordability due to mortgage rates nearly tripling from record lows coupled with home prices rising over 40% during the Housing Boom Pandemic.
Not to mention that for builders, in particular, it’s a less than ideal time to lose buyers as they deal with pandemic-related supply chain disruptions and historic backlogs. Mario Pinedo, mortgage broker at HomeLoans.LA, told fortune that rate buydowns are a way to bridge the gap between mortgage rates that have increased rapidly, and that many builders use to push to move their inventory.
“It’s a seller [offered] incentives,” Pinedo said.
It is more beneficial for builders to use the 2-1 buydown rate, Pinedo said, through the reduction in the sale price because it keeps the value up and entices buyers. Builders have had great success with buydowns, many offering buydowns that extend beyond two years.
In December of last year, 75% of homebuilders surveyed nationally said they were shopping around for buyers’ mortgage rates to keep them affordable, according to John Burns Real Estate Consulting. Some builders surveyed said that “everyone needs an incentive,” and “rate buydowns and/or rate lock promotions are the best” and “100% of the backlog is offered some type of rate buydown comparable to new sales.”
Devyn Bachman, senior vice president of research at John Burns Real Estate Consulting, previously told fortune the level of buydowns “is one of the levers that encourage consumers to buy new homes.”
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