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Buydowns: Another Tool In The Toolbelt
October 4, 2022
Another Tool to Improve Affordability
The rapid rise in mortgage rates during 2022 coupled with continued appreciation of home prices have limited the number of buyers in the market which is reflected by the lower number of home sales currently. “It’s a fact that many households are impacted by higher mortgage rates as they no longer earn the qualifying income for the median-priced home.” Nadia Evangelou, NAR Economist
One of the things that agents are doing to help buyers lower their house payments is to suggest an adjustable-rate mortgage. The rates on these types of loans are tied to indexes that reflect the current market rates and produce less risk for the lender. The payments adjust on the anniversary date based on the index plus margin named in the note.
While many people think that they only adjust upward, they also adjust downward when the index indicates it. For the week of September 29, 2022, the Freddie Mac 5/1 ARM was 5.03% compared to the 30-year fixed-rate of 6.70%.
Another tool that experienced agents are using to address affordability issues are interest rate buydowns. In recent years, there have not been many buydowns used because interest rates were already very low, but now, more people are considering them again.
A buydown is prepaying the interest on a mortgage at the time of closing to lower the payment for a specific period or for the term of the mortgage. Obviously, it would be more expensive to buydown the rate for the whole term of the mortgage.
Either the seller or the buyer can buydown the rate and it would be specified in the sales contract. From a practical perspective, sellers in the recent past haven’t had to consider this option because of the high demand and multiple offers that were commonplace. Now that sales have slowed, and both inventory and market time is increasing, some sellers want to make their homes more marketable and are seeking a competitive advantage.
A common temporary buydown is called a 2/1 which reduces the payment in the first two years of the loan by calculating the borrower’s payment at 2% less than the note rate for the first year and 1% less than the note rate for the second year. Years three through thirty, the payment would be the normal payment at the note rate.
A buydown is a fixed rate, conforming mortgage that the borrower must qualify at the note rate to indicate that borrowers will be able to afford the mortgage after the first two years of lower payments.
As an example, on a $4000,000 sales price with a 90% mortgage at 5.54% interest for 30-years, the normal principal and interest payment would be $2,053.08. By using a 2/1 buydown, the payment for the first year would be at 3.54% interest, 2% lower than the note rate, making the payment $1,624.61. The second year, it would be at 4.54% interest, 1% lower than the note rate, making the payment $1,823.63.
The buyers’ payment would be $428.47 lower each month for the first year and $220.45 a month lower for the second year. The total savings would be $7,787.04 which becomes the cost of the 2/1 buydown. This amount must be paid at the time of closing by either the seller or the buyer.
| 2/1 Buydown Example | 1st Year | 2nd Year | 3rd … 30th Years |
| Interest Rate | 4.7% | 5.7% | 6.7% |
| Principal & Interest Payment | $1,867.10 | $2,089.44 | $2,323.00 |
| Monthly Savings | $455.90 | $233.56 | |
| Annual Savings/Total Savings | $5,470.80 | $2,802.72 | $,8,273.52 |
The most prevalent providers of buydowns in the past have been builders. It is a concession like paying closing costs or upgrades for the buyer. As sales have started to slow, some builders in particular price ranges and areas are currently considering this benefit to close more sales.
To summarize: a buydown is a fixed-rate mortgage where the interest is pre-paid for a period to help the borrower with lower payments for a time. A 2/1 buydown allows the buyer to have significantly lower payments in the first two years which will give them time to settle into the house while they can be confident of what the payment will be in years three through thirty.
The pre-paid interest is deductible for the buyer, even if the seller pays for it. This is something that the buyer will want to talk about with their tax advisor when they are doing their income tax for that year.
If you are selling a home, talk to your listing agent about this option to increase marketability. If you are a buyer, discuss this as an affordability option. If your agent isn’t familiar with buydowns, ask them to research it with a trusted mortgage officer. Buydowns are legal and have been available for decades. The determining factor may be whether the market has softened enough that sellers are willing to consider them.
Rising Mortgage Rates Cause Shock
September 26, 2022
Cause to Pause
Rising mortgage rates are causing some would-be buyers to pause their decisions until they determine whether rates are going to come back down. While it may be possible, the probability is that prices are going to continue to increase past this current shock situation.
On December 23, 2021, the 30-year fixed-rate, according to Freddie Mac, was 3.05% and is at 6.29% as of September 22, 2022, a 106% increase! On a $360,000 mortgage, the principal and interest payment went from $1,528 to $2,226. The $698 difference represents a 46% increase in the payment.
It seems understandable to pause and see if rates will come down again, especially since they went up so fast, but it probably isn’t going to happen anytime soon based on the Fed’s position on controlling inflation.
The fact that inventories are growing slightly, and market times are increasing doesn’t negate that supply cannot keep up with demand and homes are continuing to appreciate, albeit, not as much as they did in 2021.
If a person waited a year to see if the rates come down but, in the meantime, the prices increased 10% and the rates stayed the same, the home in the example above, would have a $226 larger P&I payment.
As an alternative strategy, the buyer could purchase the home on a 5/1 adjustable-rate mortgage with a 4.64% rate for five-years. Instead of $2,226 for the P&I payment for the fixed rate at 6.29%, the payment on the ARM would be $1,926, a $300 savings.
They would have purchased the home at today’s prices, avoiding appreciated prices and would have five years to refinance at a lower fixed rate should they come down. Assuming the rate adjusted upward the maximum amount at each period, it would take over seven years to exhaust the savings on the lower payments for the first five years.
It is unfortunate that some buyers missed a window of opportunity to purchase last fall when mortgage rates were near an all-time low. That window has closed, and it may not open again. People who can still afford to buy, even though rates are significantly higher, are taking a risk waiting for rates to come down. Even if they are correct, the prices will be higher, offsetting any possible savings.
If they are wrong, both prices and rates will be higher, and they may be priced out of the market.
In the 1980s, when mortgage rates topped 18%, the best real estate agents in the country presented alternative financing choices to buyers. If your agent hasn’t had conversations with you about alternatives to fixed rate financing, there could be options available that you need to consider.
Depending on your price range and individual situation, investigate local and state financial assistance programs, ARM Comparison, 2/1 Buydown, and Cost of Waiting to Buy and download our Buyers Guide.
Down Payment Gift Increase!
September 12, 2022
Gift Amount Increased for 2022
The limit for tax free gifts for 2022 is $16,000 and no tax is due to the donor or the donee. There are provisions that would allow gifts higher than this amount providing the total lifetime gifts above the annual exclusion of $12.06 million for 2022 has not be met.
The donor and donee can be separate persons so that the aggregate tax-free gift for one-year amounts to more money. For instance, a father and mother can gift $16,000 each to their married son in 2022 and an additional $16,000 each to the daughter-in-law for a total $64,000.
If the son and daughter-in-law used the money as a down payment to purchase a home, depending on how recent the gift occurred, the mortgage company might require a gift letter from the parents stating the amount was a gift and is not expected to be repaid. Lenders may ask the exact amount of the gift, where it came from and the relationship involved.
Family members and friends with financial resources can become the catalyst that allows buyers with good credit and income but without a down payment to purchase a home. Sometimes, the gift is looked at as an early inheritance that allows the recipient to show their gratitude and the donor to see the enjoyment and benefit of the gift.
In some situations, the buyers have saved enough money for a minimal down payment, but the gift allows them to put more money down that may help them get a lower interest rate or eliminate the need for private mortgage insurance.
The important thing involving gift funds is to have complete disclosure with the lender. It is best discussed during the pre-approval process. Your real estate professional should also know about it so they can guide you through the process.
Consider an Adjustable Rate Mortgage
September 6, 2022
Housing Affordability – Call to ARMs
Housing Affordability is negatively affected by both rising home prices and mortgage rates. A 20% increase in nominal home prices and a 2% increase in the 30-year fixed rate mortgage since January have contributed to a 46 point drop in the NAR Housing Affordability Index.
The Index was 143 in June 2021 and is 98.5 in June of 2022. The Housing Affordability Index indicates whether a median income family can qualify for a mortgage loan with a 20% down payment and 25% qualifying ratio for monthly housing expenses to gross monthly income.
100 points is considered the tipping point. As the Index rises above that point, housing is considered more affordable and as it declines, it is considered less affordable.
With affordability threatening to limit buyer’s ability to purchase, more borrowers are considering an adjustable-rate mortgage. For the last ten years, fixed-rate mortgages have been so low, only about 3% of borrowers used adjustable-rate mortgages.
There is a lot of misinformation about ARMs that keeps some would-be buyers from even considering them. Even before the housing crisis of 2007, many safeguards were put into place to protect borrowers.
“As long as the ‘spread’ between ARMs and fixed-rate mortgages continues, more first-time home buyers may choose ARMs because the lower mortgage rate gives them a purchasing power ‘boost’ over the 30-year fixed mortgage rate.” Mark Fleming, First American Chief Economist
The potential ARM candidate is probably not a first-time homebuyer. They should be tolerant to risk and more financially savvy with predictably increasing income. These buyers may recognize that they do not intend to stay in the home for a long time.
Adjustable-rate mortgages, generally start out at a lower-rate than a fixed-rate but can adjust, up or down, based on an independent index plus a specified margin and anniversary date that are referenced in the note. Most ARMs have stated interest rate caps that limit the amount of adjustment of the rate both on a periodic basis and a lifetime. FHA ARMs have a limit of 1% per adjustment period and a 5% lifetime cap over the original note rate. Conventional loans, more commonly, have a 2% per adjustment period and a 6% lifetime cap.
A particularly popular type of adjustable-rate mortgage is referred to as a 5/1 which means the rate for the first period lasts five years and then, each adjustment period after that is for one year. This allows a buyer to have stability in the rate during the first five years. If they plan to sell in less time than that, they will not have to deal with the adjustment.
A 5/1 ARM will have a lower payment for five years because of the lower initial rate and assuming a worst case scenario, a conventional ARM could increase a maximum of 2% at the end of the first period which would put the rate at higher than the fixed rate at the time they started. However, that is not where the breakeven point occurs. It is not until all the savings from the initial period have been exhausted, that the ARM will become more expensive than the fixed-rate alternative.
An ARM Comparison can help buyers to determine breakeven point. Let’s compare a 5.66% FRM with a 4.51% 5/1 ARM with 2 and 6 caps. A $450,000 30-year term loan amount will have a P&I payment of $2,600.41 for the fixed compared to $2,286.76 for the ARM. The $317.65 monthly savings will accumulate for 60 months plus a $6,673 lower unpaid balance on the ARM due to a lower interest rate.
The total savings in the first period would be $25,732. If you assume that the payment would increase to the maximum at each adjustment period, the breakeven point will occur at 7 years and 4 months. If you were to sell the property prior to the breakeven, the ARM would produce a lower cost of housing.
One of the benefits for lenders making adjustable-rate mortgages is that they have less risk because the yield can change to reflect the current market. Most ARMs must adjust down as well as up which means if rates do come down, the buyer can continue with the ARM at a lower rate or convert it to a fixed-rate at the, then, current rate.
Use the ARM Comparison to see where the breakeven point will be for you. Get mortgage rates for FRM and ARM mortgages from Freddie Mac and download our Buyers Guide.
Are Prices Going to Continue to Rise?
August 24, 2022
Are prices and rates going to continue to rise?
One of the most talked about questions in the real estate market has to do with “Will prices continue to rise now that interest rates have increased dramatically this year?”
It is understandable to think that if the Federal Reserve is using interest rate increases to slow consumer demand, that it would also slow homebuyer demand to moderate prices. Unfortunately for would-be homebuyers, it isn’t the case. High inflation, strong economic growth, low unemployment, and increased wage growth have been associated with high home price appreciation.
In a recent newsletter from First American, Chief Economist, Mark Fleming stated that historically, 90% of total inventory is from existing homes and homeowners are not moving as often as in the past. Prior to 2007, the average tenure was five years. After the housing crisis, between 2008 and 2016, the length of time spent in a home went to eight years.
Lawrence Yun, Chief Economist with the National Association of REALTORS� when talking about the May 2022 statistics: “Nonetheless, homes priced appropriately are selling quickly and inventory levels still need to rise substantially … almost doubling … to cool home price appreciation and provide more options for home buyers.” Median sales price rose to a new high of $403,800, up 10.8% from July 2021, while sales are down 20% year over year and inventory increased slightly to 3.3 months from 2.6 months in July of 2021.
In the beginning of 2022, Fannie Mae, Freddie Mac and NAR predicted home price appreciation would be 7.6%, 6.2%, and 5.1% for the year. Their revised forecast has been increased to 16%, 12.8%, and 11.5%. Buyer demand still exceeds inventory levels which is driving prices higher.
While the Fed does not set mortgage rates, it does determine the Fed Funds Rate which is charged by banks to each other for overnight funds. The increases often affect the U.S. Treasury rates to increase and there is generally a reaction when the 10-year U.S. Treasury Note yields increase for the 30-year mortgage rates to increase also.
The National Association of REALTORS�, on their website, states “The Housing Affordability Index measures whether or not a typical family earns enough income to qualify for a mortgage loan on a typical home at the national and regional levels based on the most recent price and income data.” The Index uses the 30-year fixed rate mortgage as provided by Freddie Mac’s Primary Mortgage Market Survey (PMMS).
Mortgage rates have gone up over 2% in the first half of 2022. That dramatically affects the affordability of the home even if the price didn’t increase, which it did. A $360,000 mortgage at 3.05% in December 2021 would have a principal and interest payment of $1,528 for 30-years. At 5.22% as of August 11, 2022, the P&I payment is $1,981 or a difference of $453 dollars or a 30% increase.
As of May 2022, homeowners are now staying in their homes 10.6 years. Part of the reasons can be contributed to the pandemic, but a large degree is attributed to the lack of inventory. Existing homeowners can sell their home for premium prices and in unusually short time frames, but the problem is finding a home to replace it.
The demand for housing still exceeds the supply and price are continuing to rise, although, maybe not as the same pace as 2021. Many economists predicted that price appreciation would slow but CoreLogic reported “Home prices nationwide, including distressed sales, increased year-over-year by 20.9% in April 2022 compared with April 2021. In the same report, CoreLogic predicted “…home prices are forecast to increase on a year-over-year basis by 5.6% from April 2022 to April 2023.”
Another frequent question homeowners have is whether to wait to see if prices moderate and interest rates decline. The probability is more likely for prices to continue to increase along with mortgage rates. The consequences of waiting, in hopes of lower prices and rates, could totally price a person out of the market for the home they want.
Using a $400,000 home that could be purchased today at 5.22% on a 90%, 30-year mortgage, the P&I payments would be $1,981. If the price appreciated only 5% in the next year and the mortgage rates were to go up by 1%, the payment would increase by $339 a month. If a person stayed in the home for 7 years, the increased cost would be $28,458 and if they stayed for full term, it would cost them $121,965 more by waiting.
Increases in rates and prices have forced some people out of the market, at least temporarily. For the fortunate ones, who can still afford to buy, even with the increases, acting now could save them tens of thousands and maybe hundreds of thousands depending on the price of the home.
Make an appointment with your real estate professional to get the facts on what you home is worth, the mortgages available, and the logistics to put it together for your best advantage.