Lew Sichelman
Short-term interest rate buy-downs and free or discounted upgrades may soon be coming to a housing market near you.
Right now, the market is hot – “too hot for its own good,” said Ali Wolf, chief economist at Zonda, a research and marketing advisory firm. Builders are either staying the course or capping sales so their construction crews can keep up with demand.
But in a recent webinar, Wolf advised her clients to “begin strategizing” about what they need to do to keep selling when the market slows, as it will inevitably do. And the most frequent tactics builders employ when sales are hard to come by are temporary buy-downs and incentives.
Actually, because of skyrocketing mortgage rates and house prices, builders are already having trouble satisfying entry-level and midrange buyers.
“Qualification is starting to become an issue,” said Tim Sullivan, Zonda’s managing principal.
Wealthy Buy Most New Homes
Most new home sales these days are being made to what Wolf referred to as “people of wealth,” who are “a lot less sensitive” to rising prices and higher mortgage rates.
Nevertheless, 97 percent of builders surveyed by Zonda are raising their prices every month. Six out of 10 of those are hiking prices by $10,000 or more monthly, some by as much as $300 a day – pricing out even well-heeled would-be buyers by the thousands.
In addition, financing costs have hit 5 percent as of this writing, pushing aside buyers who can’t come up with a 20 percent down payment and don’t have excellent credit scores.
Take a gander at what happens with a 30-year, $350,000 mortgage with a 5 percent down payment. The difference in payments for principal and interest between 4 percent and 5 percent is $51 a month, $612 a year and $18,360 over the life of the loan.
Another way to look at the problem: According to CoreLogic, those who financed their houses using government-insured mortgages, many of whom were first-time buyers, walked away with a $1,710 monthly payment in the second half of last year. That’s $282 more – almost a 20 percent increase – above what they would have paid at pre-pandemic loan rates.
“Just looking at the math” makes Wolf “nervous,” she said.
Buy-Downs Beat Out Discounts
One way builders can combat the problem, obviously, is to lower their asking prices, but they are loath to do that. They see buy-downs as a better method of reaching deeper into the market because they allow more buyers to qualify for funding.
A typical buy-down, known as a “2-1,” calls for a rate that’s 2 percentage points below market for the first year. In the loan’s second year, the rate rises to 1 percentage point below market; after two years, it goes up to the original market rate, where it remains for the life of the mortgage.
Other popular versions include a “3-2-1” buy-down, in which the rate is 3 points below market the first year, 2 points during the second year and 1 point in the third, and a “condensed” buy-down, in which the rate rises every six months instead of every 12. In all cases, the builder pays the lender a fee to drop the rate.
On a $250,000, 30-year mortgage with a start rate of 6.25 percent and 10 percent down, a 2-1 buy-down would work like this: For the first year, the rate would be 4.25 percent, resulting in a $1,230 payment. In year two, the rate rises to 5.25 percent and the payment would rise $151 a month to $1,381.
Then, beginning in year three, the rate would bounce to 6.25 percent and the payment would go up $159 more to $1,540. The savings over the two-year period: $5,628.
Are ARMs an Option?
Adjustable-rate mortgages also start at a somewhat discounted rate, though not usually as much. And even though they tend to come with periodic and life-of-the-loan caps – meaning the rate you pay can only go up so much at each adjustment interval, and never more than a certain amount – they are somewhat unpredictable.
Yes, you’ll know when rate changes will occur – ARMs are usually of the one-, two- or five-year variety – but never by exactly how much. There’s no uncertainty with a buy-down, though. You know when you’ll pay more and by exactly how much. And you’ll know that once your rate reaches a certain point, it won’t go any higher.
The big advantage, of course, is that you’ll be able to qualify for financing at the lower rate. Beware, though: Some builders will jack up their prices to cover the cost of buying down your interest rate. And some might require you to use their own affiliated mortgage company, or at least one of their choosing.
Hard to Predict Impact
Builders also almost always roll out the freebies when the going gets tough. The most popular “giveaways” are options and upgrades at a reduced cost – or at no cost at all – and a percentage discount off the total price of the house. Paying the buyer’s closing costs is another popular way to land customers. Sometimes they’ll even throw in a new automobile.
It’s impossible to predict how many builders will go that route this time around, or what they will offer. But in 2008, when the housing market last imploded, nearly two-thirds offered one goody or another, according to the National Association of Home Builders.
Buyers should realize, though, that not all giveaways are created equal: Not all upgrades add value, and you’ll likely be told the item is worth far more than what it actually cost the builder.
For example, if a builder claims they’re offering you $25,000 in kitchen upgrades, they likely paid about half that for the materials and appliances in question. What you’ll really be getting is a $12,000 kitchen. And you may be able to secure a better deal for a tricked-out refrigerator at a local discount store.
Also, as with a buy-down, realize that some builders offer incentives only if you obtain your financing from a certain lender. There may be nothing wrong with that, but it’s always best to shop around to be sure.
