In a record 45.5% of home sales recorded by Redfin agents during the three months ending February 28, home sellers gave concessions to buyers.
That's the largest quarterly share in Redfin’s history since July 2020. Due to inflation and rising interest rates, concessions such as money for repairs and mortgage rate buy-downs have become standard fare.
Real estate agents favor offering concessions over lowering the buying price. With an increase in demand for this home mortgage strategy, mortgage experts expect to see this trend continue possibly until the end of the year.
What’s a Mortgage Buy-Down?
A mortgage buy-down is a form of mortgage loan in which the interest rate is reduced for the initial two or three years. The borrower makes a one-time payment to reduce the interest rate and monthly payment. This lump sum is known as the “point.” Buy-down points are often paid either by the seller or the lender, depending on the deal’s specifics.
According to Joshua Massieh, a residential mortgage expert and CEO of PacWest Funding and Real Estate LLC, one of the best programs available right now is the 2-1 buy down, which begins at a rate of 3.5% for the first year and then 4.5% for the second year. With a 5.5 rate every year after that.
For a 2-1 buy-down, Massieh explains that you’ll need some sort of seller credit of around $12,000 up front, but the interest savings over the next two years would be huge. If interest rates drop, you can refinance; if they rise, you’re still locked in at a lower rate than if you have not done the buy-down.
Seller contributions to an escrow account are common and serve to subsidize the loan in the initial years, resulting in a lower mortgage payment for the buyer. The buyer can get a mortgage with less stringent requirements thanks to the reduced down payment.
It is common practice for the seller to make payments to the mortgage lender, which lowers the interest rate and, hence, the monthly payment for the buyer.
The Problem With Mortgage Buy-Downs
According to Joshua Massieh, taking advantage of the lower payments for two years can be an attractive option, but one needs to prepare ahead. Once those two years are up, you’ll likely see your payment skyrocket. While this strategy might appear to benefit the buyer with a lower payment, behind the scenes, it is essentially just pushing more of the cost onto them, which can be far from ideal, depending on their financial goals.
The other factor Massieh further notes no one is talking about with this buy-down strategy is that the sold price doesn’t reflect the seller’s credits. For example, if a seller sells their home for $300,000 and gives a $20,000 seller credit, they are effectively selling at $280,000.
Websites like Redfin and Zillow do not pull the seller credit data, so everything is based on the higher purchase price when in reality, the market could be trending lower without anyone knowing. So home values stay flat or even go up on paper, when in fact they could be going down – drastically.
It could be a good thing as prices will never drop based on perception. Now here’s when things become tricky. According to Massieh, if a home seller sees a home selling for $300,000 next door, they will probably list their home for the same price. When in reality, that next-door neighbor could have sold for a much lower net price.
Equally problematic is that unless the buyer’s agent does some investigating, the buyer will be stuck with a house that is not worth $300,000 and will have no idea that the neighboring property actually sold for a significantly lower price.
Who Can Benefit Most From a Mortgage Buy-Down?
People who plan to relocate or refinance in a couple of years and want to minimize their monthly payments may consider a mortgage buy-down.
Dr. Adam Leffler is a real estate investor and founder of the real estate-themed TV network Bargain House Network. According to him, if someone can realistically afford a mortgage payment at what they expect to be the long-term rate, then saving money upfront can be a great idea.
But, if they are only able to afford the mortgage because of the buy-down, then it’s gambling.
“We all saw how that worked out during the 2008 real estate crash,” Leffler says, “where homeowners did a buy-down to afford the payments but were no longer able to afford the payment after the buy-down period ended.”
While some have claimed that it’s safe because lenders wouldn’t make the loan if it were a real danger, Leffler points out that this ignores the reality that most lenders will package and sell the loans they make to the secondary market in less than a year, so they don’t really care.
Are Sellers Encouraging Buyers to Overspend?
Leffler believes argues that most buyers want as much of a home as they can afford, which often leads to these kinds of choices, so the result is the same. He feels sellers are not encouraging buyers to overspend with buy-downs.
Most are driven by the payment rather than the terms because they lack the financial literacy to understand what they’re getting into. “Ultimately,” Leffler says, “it’s up to the buyer to make the responsible decision.”
Andrew Rhodes, Senior Director, Head of Trading at Mortgage Capital Trading (MCT), argues that the buy-down loan is underwritten at a certain approved rate to ensure the borrower can make future payments at that rate. “Considering this,” he says, “mortgage buy-downs would not encourage the buyer to overspend as they would still need to qualify for the loan given their credit profile at the approved rate, not the discounted rate.”
Adjustable Rate Mortgage versus Mortgage Buy-Downs
Buy-downs are updated annually for the first two to three years, whereas ARMs are fixed for a while and then reset based on a benchmark or index, plus an additional spread known as an ARM margin. The buy-down’s modified annual rate is determined by the buy-down’s structure, the terms of which are discussed and agreed upon in advance.
Leffler explains that adjustable-rate mortgages will buy down the rate temporarily but adjust periodically throughout the life of the loan. This is far riskier than a mortgage buy-down, where the adjusted payment is more predictable. The mortgage buy-down, however, can also be used to bring down adjustable-rate mortgages for some time, but this combination should be avoided because of the extreme risk.
Between the two, “I think mortgage buy-downs can be a good option,” he says, “but only when the buyer can realistically afford the home even without it. In our current economy, I would avoid adjustable rate mortgages like the plague, though.”
Essentially, each case should be carefully examined in the context of the transaction by a professional who’s aware of the borrower’s short and long-term financial goals.
This article was produced and syndicated by Wealth of Geeks.
source https://wealthofgeeks.com/mortgage-buydowns/
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