One option is making a comeback…
Rising rates have emerged as the bogeyman of inflation, hitting homeowners in the pocketbook where the impact is felt more acutely. Against this backdrop, temporary interest rate buydowns are making a comeback.
Peter Idziak (pictured), an attorney for the Dallas-based residential mortgage law firm Polusnky Beitel Green, previously spoke to Mortgage Professional America about buydowns in general. Given the mercurial nature of today’s market, temporary interest rate buydowns – particularly the 2-1 buydown version – are increasingly being seen as a haven for lowered interest rates.
With buydown talk escalating as a hedge against rising rates, one will likely hear talk of points or discount points. “Those terms in the industry are usually used to refer to permanent interest rate buydowns,” Idziak explained, noting they cover the entire life of a loan. Conversely: “Temporary buydowns can be provided by any party. A buyer could provide it, but normally what you see is a seller providing it. What it does is it buys down the interest rate over the first two years of the loan.”
The most popular version emerging is the 2-1 iteration: “In a 2-1 buydown, the interest rate would be reduced 2% in the first year of the note and 1% in the second year,” Idziak said. “So how does that work? The seller basically puts a certain amount of money that’s based on the lender requirements – essentially what their valuing those interest payments at – into an escrow account and then the borrower basically pays a monthly payment over the first two years of the loan that’s reduced. The gap between that reduced interest rate and the note rate is paid out of the escrow account until that escrow account is depleted, which based on the math would be at the end of year two. So that at the start of year three the borrower would be paying the full principal and interest payment based on the note rate.”
Read more: Mortgage buydowns touted as reprieve from soaring rates
In other words, the 2-1 financing lowers the interest rate before it rises to the regular, permanent rate.
Beleaguered homeowners have taken another look at adjustable-rate mortgages as another reprieve from interest spikes. Idziak noted the GSEs allow for co-mingling the two forms of financing, to a fashion: “Fannie/Freddie do allow for temporary buydowns on ARM loans, so long as the buydown period is shorter than the ARM’s initial interest rate period,” he said. “So, for example, on a three-year ARM, the buydown must be structured as a 2-1 buydown with a buydown period no longer than 24 months. However, some private investors will only allow buydowns on fixed rate loans.”
As to government loans, the attorney added, FHA does not permit a temporary buydown on ARM loans, while VA does.
“So to the extent a borrower could obtain an ARM and receive a seller-paid temporary buydown, they could realize the benefits of both a lower introductory interest rate under the ARM and a further effective reduction in that rate due to the temporary buydown,” he said.
Yet given the roller-coaster nature of the economy in these times, ARMs may not be the best option, he suggested. “With the volatility that’s happening right now, there’s the thought that ARMs might be a way to kind of lock in a lower rate if you thought either that you were going to be in a home for seven years or less – before that 7-1 ARM resets – or maybe you could refinance after seven years. But with the yield curve briefly inverting and pricing being highly volatile that may not turn out to be that beneficial.”
But then again, things are hard to predict these days: “I don’t want to speculate too much because I’ll give you this quote and something happens a week from now or two weeks from now and ARMs are back with a vengeance.”
Read next: Adjustable-rate mortgages – the answer to housing market volatility?
The ensuing power equilibrium change makes temporary buydowns that much more appealing to some, he added: “What a buydown really reflects is that you’re seeing a rebalance of the power in the purchasing account, in the home purchase market, from sellers to buyers,” he said.
Beleaguered builders have begun to take notice, viewing temporary buydowns as a creative incentive to secure buyers, Idziak added. “Where we normally see buydowns start is with builder clients,” he asserted. “Why would builders want to provide these incentives to buyers? There are two main reasons for builders. The first is it may help reduce their holding costs. So, to the extent that builders may be starting to sit on inventory, using an incentive like a buydown can help them reduce those holding costs. The second one that really impacts builders a lot is that in a lot of states, the sales price of a home is common knowledge. If you reduce the sales price, you put all potential buyers on notice. But with a temporary buydown, you can incentivize your buyers that may need it for affordability reasons without publicly reducing your sales prices.”
Given the topsy-turvy nature of today’s mortgage industry, you may very well see more people giving rates that 2-1 punch.
