It’s a terrible time for homebuyers. Mortgage rates for a 30-year fixed-rate loan are hovering around 7% levels and still-high home prices are slashing purchasing power.
What helped Erica Davis, a loan originator at Guild Mortgage, in the current high-rate environment is a seller-funded temporary 2-1 rate buydown. By taking advantage of the 2-1 temporary rate buydown, Davis was able to lower her 7.25% mortgage rate by 2% in the first year and by 1.5% in the second year.
The seller, who struggled to find a buyer in a cooled down housing market, agreed to deposit a lump sum payment into an escrow account at closing – ultimately saving Davis $6,900 in monthly payments in the first two years.
“Absolutely I’m going to refinance when the rates go down, and that’s why I decided on a 2-1 rate buydown,” Davis said. “It helps to have that lower payment, and the extra cash flow gives you a little more flexibility, so you’re not so budget-tight.”
In a high-rate environment, lenders call the temporary rate buydown a win-win strategy for both sellers and buyers when used appropriately. Despite homeowners being disincentivized to give up their low mortgage rates and move, buyers are still out there, and the silver lining for buyers is softened competition compared to the red-hot housing market from the past two years.
“As rates increase and housing prices correct in 2023, sellers will want to take advantage of improving their chances to do business with an excited buyer who can obtain a lower than market rate with seller participation,” Jeff Miller, vice president of Pacific Northwest at Churchill Mortgage, said.
Sellers, including homebuilders, can also gain a competitive edge by being flexible in terms of offering credits or concessions, like temporary rate buydowns, an attractive option that gives borrowers a reprieve to combat the housing affordability challenge.
“If the process is explained correctly to both parties, sellers and buyers will enjoy seeing each other win and accomplish the goals each party has,” Miller said. “It gives the buyer and seller the feeling of beating the mutual enemy, ‘the market,’ and gaming the system.”
Lenders seize opportunity for lost volume
With the mortgage market rapidly shrinking – some experts believe it might contract to just $1.3 trillion in origination volume in 2023 – numerous lenders have rolled out the option of temporary buydowns and have joined in providing concessions to buyers to help compensate for lost origination volume.
United Wholesale Mortgage, the country’s largest mortgage originator, most recently expanded buydown options to include a lender-paid version, in addition to the seller-paid one. The wholesaler was among the first to offer 2-1 and 1-0 temporary buydowns, which are not new products but haven’t been used much over the last decade.
“Absolutely I’m going to refinance when the rates go down, and that’s why I decided on a 2-1 rate buydown.”
Erica Davis, Guild Mortgage loan originator and home buyer
Rocket Mortgage has also launched a lender-funded 1-0 rate buydown, dubbed the “inflation buster” program, as well as a seller- or real estate agent-funded 1-0 rate buydown from its wholesale arm Rocket Pro TPO.
“Temporary rate buydowns are a great tool for brokers and realtors to have in a rising rate environment,” a spokesperson at UWM said.
The Michigan lender said they’re “getting a lot of traction,” but said it wasn’t able to provide data given that temporary rate buydown options to borrowers are “so new.”
loanDepot, Guild Mortgage and NewRez are also among the lenders that either cover the difference in mortgage payments or offer the option of a seller or builder-paid temporary rate buydowns.
From the investor’s perspective, a 30-year fixed-rate conventional loan or a mortgage locked down with a temporary rate buydown will carry the same risk. The payment the lender receives is always the same, as the seller funds the escrow account to make up the difference for the lender.
“Fannie Mae and Freddie Mac require the lender selling it to underwrite the borrower at the undiscounted note rate, so there is no worries about teaser mortgages that reset at higher rates,” said Peter Idziak, senior associate attorney at Polunsky Beitel Green.
Not a one-size fits all scenario
Depending on the market, LOs say they’ve seen as little as 10% of their total loans closed with temporary rate buydowns — or as high as 60%.
It’s not a one-size fits all scenario and is dependent on borrowers’ situation.
Borrowers who would benefit from a temporary rate buydown are those who are getting into the market and plan on hanging onto the property for two to three years before moving up to a different type of property, Trudy Kelly, a senior loan officer at Churchill Mortgage, said.
Borrowers who plan on having the property long term will have to stomach the higher rate when the temporary buydown ends and the rate reverts to the original quoted rate.
“Fannie Mae and Freddie Mac require the lender selling it to underwrite the borrower at the undiscounted note rate, so there is no worries about teaser mortgages that reset at higher rates. “
Peter Idziak, senior associate attorney at Polunsky Beitel Green
“If for some reason interest rates don’t drop in the span of 24 months from closing, then they won’t have that ability to refinance that into a lower rate and… reduce the payment for the life of the loan,” Kelly said.
Borrowers with enough cash, for instance, could consider an all-cash offer, could throw more at the down payment to reduce the amount of the mortgage or choose a permanent rate buydown. Often called “buying points,” the borrower could reduce the interest rate, resulting in greater savings over the life of the loan.
For buyers who may be moving out of the home within 10 years, an adjustable-rate mortgage (ARM) — which offers a reduced fixed rate for typically 5, 7, or 10 years, after which the rate resets to current market rates – could be an option, depending on how attractive ARM rates are.
A 5/1 ARM on Nov. 22 was 6.24% while a 30-year fixed-rate was 6.64%, according to Mortgage News Daily.
Thinking outside the box
Every buyer has unique financial circumstances, and that’s why educating LOs on temporary rate buydowns has become crucial for lenders, Blake Bianchi, founder and CEO of Future Mortgage, said. The buydown option is not a new concept, but for loan officers who joined the refi boom, it’s a new concept they need to learn.
“As a LO, you should be knowledgeable about temporary rate buydowns because it’s making up a majority of the loans now in this market,” Bianchi said. Bianchi, who leads a mortgage brokerage of 12 loan officers, forecasts about 60% of their loans in November to close with a temporary rate buydown, up from last month’s 50%.
“If for some reason interest rates don’t drop in the span of 24 months from closing, then they won’t have that ability to refinance that into a lower rate and… reduce the payment for the life of the loan.”
Trudy Kelly, senior loan officer at Churchill Mortgage
After seeing purchase contracts getting closed with seller credits and builders offering concessions, Bianchi saw potential benefits in offering temporary rate buydown options for borrowers. It’s been about three months since Bianchi started training LOs on what a temporary rate buydown and a permanent rate buydown (buying points) is to help them better educate the clients.
“We don’t want LOs convincing clients that rates are going to be low for three years, for example, and not have clients be able to afford payments after that. It does take education from LOs to clients as well setting realistic expectations,” he said.
It’s about getting creative and thinking about whether there is negotiation power for borrowers, said Churchill Mortgage’s Kelly in regard to helping clients find ways to lower their monthly mortgage payments.
Kelly recently helped a client run through a scenario of getting a $15,000 seller concession to fund their 1-0 temporary rate buydown rather than asking the seller to lower the listing price. Her client closed on the house and will be saving $341 every month for the first year.
“There’s a few that have pushed the pause button because they’re priced out of the market with interest rates rising. There are stalemates from one neighborhood to the next, which has forced us to think outside the box for our clients,” Kelly said.
This is still one of the most misunderstood programs in the market. Education is key, especially amongst RE agents so they understand how it works and the collaboration needed to make it work during negotiations.