[New] Buydowns Vs Price Cuts: We Have A Winner

Mortgage originators need to make sure they tout benefits of buydowns

BY LEW SICHELMAN, CONTRIBUTOR, NATIONAL MORTGAGE PROFESSIONAL MAGAZINE

Home builders are using the hell out of mortgage rate buydowns to bring would-be buyers to the table. Individual sellers, not so much.

The latest study from the National Association of Home Builders shows that one in four builders is buying down the rate for customers who sign on the dotted line. But John Burns Real Estate Consulting says that percentage is much higher among its builder clients. In a recent national survey, three out of four confirmed they are paying lenders to lower their buyers’ loan costs to make their payments more affordable.

But in what is perhaps an offhand comment in a recent newsletter, the Irvine, Calif.-based marketing firm noted that “few sellers are offering these savings to prospective buyers.” Why this phenomenon is occurring wasn’t noted. But it seems to me there are plenty of culprits to go around.

Start with real estate agents, both those who list houses for sale and those who bring would-be buyers to sellers’ doors. It seems to me that both subgroups should be advising their clients about the benefits of a buydown — to the seller who might need a little help finding qualified buyers and to the buyer who might need a little help making his house payments, at least when he’s starting out.

Tout From The Treetops

Next on my list of perps are mortgage brokers and funding lenders, both of which should be touting temporary buydowns to would-be borrowers from the treetops. That is, their first-year payments for interest and principal can be made substantially lower. Perhaps even their second-year payments can be reduced as well. And maybe, if the seller is willing, the borrower’s monthly outlay can be lowered for the entire term of the loan.

That last one’s a stretch, admittedly. But according to the Burns firm, about a third of the surveyed builders are buying down buyer’s mortgage rates for a full 30 years. To do that, they’re paying the roughly 5 to 6% of the sales price up front to the lender, effectively prepaying the interest on the loan. A slightly lower percentage are opting to reduce the rate for the first two years of the mortgage, while the remaining were identified as offering a one-year buydown or another, less common form of alternative financing.

With a 2-1 buydown, a builder would pay roughly 2% of the loan amount. That would bring the rate down from, say 6.5% to 4.5% in the first year of the mortgage. In the second year, the rate would bump up a notch to 5.5%. And then, starting in the third year and lasting for the duration, the rate would return to 6.5%.

So, assuming a conventional mortgage with 20% down, a 2-1 buydown would cost 2% of the sale price, the Burns firm says. On a $340,000 house, the cost, then, would be $6,300. But the drawback is that, for the most part, borrowers still have to qualify at the highest rate. Those who can gain “some breathing room.”

Help For Those Who Need It

For those who can’t qualify, builders are switching to full-term buydowns so their customers can make the grade. To do so, though, is expensive. To cut the rate on the $340,00 house in the example used above, the cost is $16,300. On a $590,00 house, it would be a whopping $28,300.

“Builders love buydowns,” says Kevin Parra, CEO of Plaza Home Mortgage in San Diego. “They always have.”

It’s doubtful many individual sellers are willing to donate twenty grand or so of their profits to the strangers buying their homes. But the cost of the shorterterm buydowns is much more palatable.

I asked Parra and his team at Plaza to work up a few examples for a house selling for $375,000. Assuming a 20% down payment, the loan amount would be $300,000. At Plaza, a wholesaler that works through both the broker and correspondent channels, the cost to the seller on a 2-1 buydown would be 2.2 percent, or $6,600.

The savings to the buyer, though, is considerable: $366 a month in the first year before dropping to $188 monthly in the second. A one-year buydown would save the borrower $188 a month, but the cost to the seller is just 0.75% of the loan amount.

But there’s a somewhat hidden benefit to buydowns most people fail to consider. If rates come down and the same time, 29% are paying their buyers’ closing costs and 27% are offering options or upgrades at no or reduced costs. In Texas, Ben Caballero, the Guiness world record holder for residential real estate sales, tells me 95% of the sales by builders in the four major Lone Star State markets come with $20,000 to $30,000 in buyer incentives.) the borrower refinances before the buydown period comes to an end, Parra points out, the prepaid interest — that’s what a buydown really is, prepaid interest — what remains in that escrow account is returned to the borrower, not the seller.

But the benefit to the buyer by lowering the price is minuscule compared to the savings generated through a buydown. In our example above, dropping the price $5,000, from $375,000 to $370,000, saves the buyer just $24 a month, an amount that hardly makes a difference.

Plaza was one of the first to market buydowns. Connecticut-based Planet Home Mortgage also is a long-time player. Now, others are starting to find the market. Most recently, I’ve noticed that LoanStream Mortgage in Irvine, Calif., is offering 2-1 and 1-0 buydowns on both conventional and FHA loans.

LOWER PRICES NOT AS GOOD?

Now let’s look at how the above example stacks up against lowering the price, say, by $5,000. Lowering prices to attract more interest is a familiar tactic, of course. Even builders are dropping prices in the current market. About 30% are trimming prices or reducing their margins, the NAHB reported recently.

(Actually, builders are pulling out all stops these days, the NAHB found. Either instead of cutting prices or at

Meanwhile, Hollywood, Fla., based A&D Mortgage is offering 3-2-1 buydowns. And United Wholesale Mortgage has expanded its buydown program to include prime jumbo borrowers.

Now it’s time, it says here, for brokers and real estate agents to get in the game. n

Lew Sichelman is a contributing writer to National Mortgage Professional magazine. He has been covering the housing and mortgage sectors for 52 years. His syndicated column appears in major newspapers throughout the country. He also has been real estate editor at two major Washington, D.C., dailies and spent 30 years on the staff of National Mortgage News, formerly National Thrift News.

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