The second half of 2022 saw the blazing US housing market plunge into a sharp and brutal downturn. It will happen when mortgage rates rise 3% to 6% just after U.S. home prices soared more than 40% during the pandemic real estate boom.
Unlike sellers of existing homes who can simply wait out the storm, American homebuilders, who have a historical number of units in their order book— have no choice but to sweeten the deal for new buyers in 2023. Their motivation for choosing? Aggressive mortgage rate buybacks.
How do mortgage rate buyouts work? Essentially, builders pay lenders a lump sum to lower mortgage rates for potential buyers. For example, a builder can offer a 2-1 rate buyout, in which the mortgage rate is reduced from 6% to 4%, and based on the agreement, the rate would increase each year by 1 percentage point up to until it reaches 6%. %.
“If you look back over time, there are different incentives that work at different time periods – the reason the rate reduction is working right now is that the rates got so high,” Devyn Bachman, vice-president senior president of research at John Burns Real Estate Consulting, Told Fortune. “It’s always been a thing, it’s just that it’s the popular choice in today’s market.”
Although the temporary 2-1 rate buyout is frequently used to make an offer more attractive, Bachman said consumers favor term buyouts. That means they’re “buying off the rate for that person’s entire mortgage,” Bachman said.
Since last month, 75% of interrogates Homebuilders said they were buying up buyers’ mortgage rates to make payments more affordable, according to John Burns Real Estate Consulting. That same survey found that 32% of builders buy back the full 30-year term, while 30% only temporarily reduce the rate for the first two years.
Bachman said Fortune that large incentives reinforced by rate buybacks encourage more consumers to consider buying new homes rather than existing ones, as the resale market cannot compete with these offers.
The company’s latest survey of builders found new home sales rose 11% from November to December, she said. And while there are several factors at play, the incentive for rate buybacks carries some weight in deciphering the improvement.
“There are a lot of factors at play, but rate buybacks and their size are definitely one of the levers encouraging consumers to buy new homes,” Bachman said.
When it comes to the cost of mortgage rate buybacks for builders, each 0.25% rate reduction typically costs about 1% of the loan amount. But with the market just beginning to see signs of depressurization, that’s often the only incentive builders can offer buyers to push the sale.
However, the cost of a rate buyout varies and depends on a few factors, including: the price of the home and the down payment – which in itself varies depending on whether the market is affordable or unaffordable – the type of loan and the type of redemption.
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