Homeowners and hopeful homeowners aren't the only ones who have been impacted by the rapidly changing real estate market. Almost everyone involved in the process, from lenders to appraisers, has been feeling the pinch since the market started to cool down, which has prompted some in the industry to adapt to the changing climate. Homebuilders in particular have been affected by this cooling market (mostly caused by higher interest rates) — with new construction down about 20% from the previous year.
Though builders are more optimistic now that interest rates have dropped slightly, they are certainly making it easier for buyers to afford to purchase a home at a higher rate by offering incentives like interest rate buydowns to their customers. We talked to mortgage and real estate experts to find out what it means, and why it might be a good way for some people to save on their mortgage.
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Meet the Experts
Homebuilders Are Offering Perks to Woo Buyers
In recent years, Shaun Martin, owner and CEO of We Buy Houses in Denver, says many builders have started offering buydown programs to move inventory. "A buydown is when the builder lowers a borrower's mortgage rate for an initial period of time, usually three or five years," he tells Hunker.
"The idea is that by reducing the monthly payment, borrowers can afford a more expensive home or different type of loan product than they could initially afford," Martin continues, adding that this benefits both the buyer and the homebuilder since hopeful homeowners are able to purchase their dream home, and builders are able to move inventory that would otherwise remain on their books.
How Do Buydowns Work?
Since consumer buying power has gone down each time the Federal Reserve Bank has inched up interest rates, Anna Young, senior new home consultant with Landmark Fine Homes, says custom homebuilders like the one she works for have begun partnering with their preferred lenders to offer long-term rate locks as well as interest rate buydowns to potential buyers.
Young says these rate changes have had a big enough impact on borrowers that homes they may have been able to easily afford just six months ago are suddenly out of reach. "By offering our rate buydown, customers' monthly payments are reduced the first few years, allowing some breathing room and the opportunity to refinance while living in their new dream home," she continues. "This is a great incentive that reduces the interest rate 2 percent in year one and 1 percent in year two, and year three returns to the original rate [unless refinanced]."
Some builders have also started discounting their homes to become more affordable, but Young says that can decrease the value of the neighborhood and hurt their other customers.
You May Not Get to Pick Your Lender
If you are hoping to close on your home with a builder buydown, you may need to move forward with a lender of the builder's choosing. "Typically, local lenders have more time and attention to make the transaction go smoothly, and there won't be the hidden fees of some of the national lenders where you end up speaking to a different person every time, and you won't know their responsiveness (or lack thereof) until it's too late," Young says, explaining why her company likes to use certain banks.
"We do allow our customers to use other lenders (as I imagine every builder would), but we only offer the buydown and other incentives — like paying the interest during the construction loan — with our preferred. To us, it's worth it to pay thousands of dollars to ensure a positive buying experience."
Buydowns Aren’t the Only Perks Builders Are Offering
While a lower interest rate is obviously a massive benefit, Martin says it's not the only way to take advantage of the savings. "The buydown can be applied toward closing costs or used to reduce the loan amount and interest rate. In some cases, builders will also give credits that lower a borrower's monthly payment during the program period."
Martin adds that builders may work with buyers to find the right loan program as well. "In some cases, builders will offer fixed-rate loans and in others, adjustable-rate mortgages."
A Buydown Isn't One-Size-Fits-All
Different builders may go about their buydowns in different ways, according to Tyler Forte, CEO of Felix Homes, who recently helped a buyer close on this type of loan. "One of my clients just purchased a home built by Drees," he says, adding that they offered them a "2-1 buydown."
Forte says this meant that the payment was based on an effective interest rate of 2 percent lower than the original rate the borrower locked into during the first year. "In year two, [their] payments will be based on a rate that is 1 percent less."
In this situation, Forte says that Drees Homes covered the difference between what the payment would typically be and the adjusted "bought-down rate."
Can Builder Discounts Be a Homebuying Hack?
For those who are struggling to afford a home at today's interest rates, moving forward with a new build may be a good way to get a lower price. That being said, Forte doesn't want people thinking that a new build is the best way to get into a new home. "Buyers just need to keep in mind that generally speaking, new construction homes are more expensive (on a price per square foot basis) than existing homes," he says. "This means a homebuyer may need to be open to a smaller new construction home if they are truly looking for 'affordability.'"
Additionally, there's the added factor that these types of buydowns only last for a few years. "So, if a buyer cannot refinance after this promotional period, they need to assume that their monthly payment will go up," he explains.
"This 'hack' can be a good idea if rates go down in the coming years, and they are able to refinance," he says. "That being said, this is no guarantee. If rates remain elevated, a buyer should feel financially comfortable paying the 'nonpromotional' rate."
Homebuilder Buydowns Don’t Last Forever
Unlike when you take out your mortgage, these types of buydowns will typically expire after a certain period. "Most typically, the buydown rates last for five years, after which time the loan reverts to its original rate," Martin says. "Borrowers are typically responsible for paying any remaining balance of their loans at that time."
It's important to remember that a buydown is an incentive and not a guarantee, according to Martin. "Prices may vary depending on location, builder, and loan type being offered," he says. "Buyers should do their research and shop around before making a decision. Additionally, be sure to communicate with your lender about any additional fees or costs associated with the buydown program, as they may add up quickly."
Buyers should always be aware of the terms and conditions associated with the buydown program before entering into it. "The most common concern is that borrowers may find themselves in a difficult financial position when the buydown ends and their loan rate reverts to its original level," says Martin. Additionally, Martin warns that buyers will need to be mindful of any fees or penalties they may incur if they decide to refinance or pay off the loan early.