Mortgage interest rates are on the upswing; there’s no contesting that. Higher rates automatically associate with higher payments and higher payments result in fewer qualified borrowers. The seller’s market, which the real estate world has experienced for so long, is rapidly coming to a close.
A seller’s market evolves when there are more buyers seeking to buy homes than homes that are available for sale. When sellers receive multiple offers, they maintain the leverage and can pick and choose the ideal offer to accept. Buyers scramble to outbid each other and homes ultimately sell for way beyond their initial asking prices. This, of course, drives home prices up. Supply and demand at its finest.
When mortgage interest rates rise resulting in fewer qualified buyers, the demand inferno ultimately cools. Sellers soon find themselves at the mercy of the buyers who now hold the leverage. In a buyer’s market, there are fewer qualified buyers and more available inventory. In a buyer’s market, the buyer will typically be able to negotiate price reductions and other incentives as a condition of tendering an offer because, let’s face it, if the seller refuses to “sweeten the pot,” there are plenty of other properties being sold by sellers who are willing to offer incentives.
One such incentive that is no stranger to a buyer’s market is the temporary buydown. You may also encounter it referred to as the 2-1 or 3-2-1 buydown. Similar to seller’s concessions through which a seller agrees to forgo a portion of the proceeds from his or her property’s sale to the buyer to offset his or her settlement fees, the temporary buydown also requires the seller to forego a portion of the home sale’s proceeds. Instead of using that money to offset the buyer’s settlement costs, however, the money is disbursed to the buyer’s mortgage company and used to supplement the buyer’s mortgage payments for a defined period of time.
The most effective way to illustrate how a temporary buydown works is through an example. Let’s assume that a buyer is a bit reluctant to tender an offer but the seller wants to tip the scales and facilitate the transaction. The seller, to do so, offers the buyer the benefit of a 3-2-1 buydown if he agrees to buy the home. If the buyer agrees, here is how this will play out.
For the sake of this example, we’ll say that, to buy this home, the buyer would secure a 30-year, fixed-rate mortgage for $200,000 at 6%. Such a mortgage corresponds to a monthly principal and interest (P&I) payment of $1,199.10. This is the P&I payment amount that the lender will want and expect from the loan’s first month through its 360th. Through seller’s concessions issued in the form of a temporary buydown, the borrower will remit a payment amount of $843.21 during the loan’s first year corresponding to a payment amount at 3% fixed, which is three percent below the note’s actual rate. The mortgage servicer, however, requires the 6% payment amount of $1,199.10. As such, the seller must concede twelve payments of $355.89 representing the difference between the required monthly payment amount of $1,199.10 and the permitted monthly payment amount of $843.21. The total concession for the loan’s first year, therefore, amounts to $4,270.68 ($355.89 x 12).
Upon year two’s arrival, the borrower “steps up” to a $954.83 payment amount equivalent to a 4% rate which is two percent lower that the note’s actual rate. Since the mortgage servicer continues to expect the $1,199.10 monthly payment, the seller, at the settlement, would also have had to set aside an additional $2,931.24 which constitutes 12 payments of the $244.27 difference.
In year three, the borrower is expected to remit a $1,073.64 payment amount which is equivalent to an interest rate of 5% and one percent below the loan’s actual note rate. With, the mortgage servicer, however, wanting $1,199.10, the seller, at settlement, would have been required to forgo an additional $1,505.52 corresponding to twelve payments of the $125.46 difference.
With each payment that the borrower remits during his loan’s first three years, the mortgage servicer supplements the amount received from the borrower with the difference between what the borrower paid and what was technically due. The money that the seller issued at settlement through seller’s concessions sits in a suspense account maintained by the mortgage servicer into which the servicer taps each month to satisfy the required payment amount.
Through this example, the seller would have conceded a total of $8,707.44 to the mortgage servicer to be used to supplement the borrower’s monthly payments during the loan’s first three years ($4,270.68 + $2,931.24 + $1,505.52). In year four, when the last of the seller’s concessions are exhausted, the borrower will then “step up” and begin remitting the true payment amount of $1,199.10.
The 2-1 buydown works in the exact same manner. The only difference is, whereby the 3-2-1 buydown affords the borrower the ability to remit a reduced payment amount for the loan’s first three years, the 2-1 buydown only offers the reduced payment for the loan’s first two years.
Of course, regardless of which option the seller offers, when structuring the temporary buydown, the mortgage loan originator must ensure that the amount of funds needed to finance the temporary buydown falls within the acceptable seller’s concessions limitations for the loan product being originated. Additionally, the borrower will have to qualify for the loan based upon the note rate’s actual payment amount and not upon any of the discounted payment allowances.
Temporary buydowns should be discussed with each borrower who is seeking to purchase a home during a buyer’s market. If the seller of a property in which your customer is interested is not already offering it, it will never hurt to ask. Unless, of course, the seller already happens to be entertaining multiple offers.