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What Is a Builder Buydown Mortgage?
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If the search for your next home is leading you to new construction instead of an existing house, you’re not alone. New residential permits, “starts” and completions were all up in May. And just like most buyers of existing homes, you’ll probably need a home mortgage loan to pay for that never-been-touched abode.
All homeowners want their best deal possible on their mortgage, but those buying new construction have a partner in the deal who may be especially motivated to sell — the home builder or developer, who won’t see a profit until the neighborhood starts selling. A buydown is a way to attract buyers by reducing their interest rates and lowering their monthly payments.
A buydown isn’t just for home builders or developers, but it’s so common it’s often known as a builder buydown mortgage and can certainly take a chunk out of the expenses that come with buying and outfitting a brand-new house.
Builder buydowns explained
In a nutshell, builder buydown mortgages are subsidized by the company building your house. The builder will put down money to lower your mortgage payments or help you obtain enough financing to afford the home. Individual sellers will sometimes agree to buydowns as well if they are keen to close a sale quickly.
Permanent vs. temporary buydowns. Buydown agreements are either permanent or temporary, depending on how your builder and the lender structure the terms. In a permanent buydown, the builder or seller will pay cash to reduce your payments, and you’ll receive a lower interest rate for the duration of your loan. A temporary buydown agreement gives you a more favorable interest rate for the first several years of the loan, after which it will increase.
Two common types of temporary buydowns include:
- 3-2-1 buydown – Initial payments are lowered for the first three years of the mortgage.
- 2-1 buydown – Lower payments for the first two years of the loan.
In either case, you’ll see the largest rate reductions in the first year, and the rates will increase each subsequent year of the buydown period, after which the fixed rate will begin.
Nathan Pierce, a Utah-based mortgage specialist, explained that if you take a 3-2-1 buydown mortgage, your interest rate will be 3% lower than the final rate for the first year, 2% lower than the final rate for the second year and 1% lower for the third year. The same applies to the 2-1, except you’ll pay 2% below the final rate for the first year and 1% below for the second year. At the start of the third or fourth year, depending on your buydown structure, you’ll begin paying at the final rate, which will be in effect until the end of the loan.
Builders tend to prefer temporary buydowns. “It’s an incentive to the buyer to help them out with their cash needs and then also gives them the benefit of a little bit of a lower interest rate over the years,” said Mary Catchur, founder of a Tampa-based mortgage lender and brokerage.
Catchur said that oftentimes a seller or builder will pay a certain amount toward the buyer’s closing costs, which they can then apply to buying down the interest rate on the mortgage themselves. You’ll pay “discount points” to your lender in exchange for decreased interest rates. However, in a builder or seller buydown, you are looking for them to pay into the loan.
|The pros and cons of a temporary buydown|
|New construction comes with expenses many existing homes don’t, such as new appliances — money saved during the introductory period can be put toward furnishings.||You may be unprepared for a larger monthly mortgage payment once the initial period ends.|
|Buy more house — a lower mortgage payment may mean you could afford a larger house than you could otherwise afford.||Plans for a higher income or to sell the home once that period ends may not come to pass.|
Whether you receive a permanent or temporary buydown, this type of loan can provide much-needed financial flexibility. A temporary buydown softens the blow of paying high installments on a brand-new house and eases you into full payments. The money you save each month during that initial period could be used for new furniture, appliances and other necessities that come up as you settle into the home, Pierce said.
Of course, temporary buydowns mean inevitably higher interest rates. However, borrowers who expect their salaries to increase by the time that happens may want to take advantage of the lower initial payments.
But Pierce cautioned that most borrowers don’t have the luxury of guaranteed salary raises. Lower initial payments may make a house seem affordable at first, but you’ll be responsible for the larger payments whether you get a promotion or not. The same is true if you plan to sell the house before the introductory period ends — unless you’re able to sell on your timeline (by no means a sure thing), you could find yourself with payments that are extremely difficult for you to manage.
“A year, two years, three years is not a very long period of time,” Pierce said. “I think [borrowers] need to be able to look at that lower payment as a perk, but they need to realize what their end payment is going to be. If they cannot budget and feel comfortable with that payment at the end of the buydown period, they’re probably delaying the inevitable — financial stress, being house poor, all of those things you hear about.”
Tip: Budget based on the higher payment. Pierce recommended that borrowers find out what they can expect their payments to be at the end of the initial rate period and make their decisions based on that number, not on what they’ll pay during the first few years. If you can’t afford the higher number at the time of purchase, you may be getting in over your head.
But it’s also important to take a full view of the buydown offer, as Catchur suggested. While saving a certain percentage a month sounds good, she said that the savings may not amount to all that much if the loan is on the smaller side and the buyer plans to sell the house in a few years. But if you’re taking out a large mortgage on a house you expect to live in for many years, the savings could become more substantial.
“The main thing is not to get focused on the interest rate, but really to analyze how much buying down that rate is going to save you in the long term,” Catchur said.
The builders’ perspective
Builders and sellers don’t offer buydowns to be kind. Oftentimes, they’ll use buydowns to incentivize buyers or to increase approvals for their properties. A builder whose company is putting up a new luxury development doesn’t want their houses sitting vacant for months or years; they’re eager to get buyers into those homes.
Buydowns help them fill houses because they’ll work with lenders to secure lower interest rates, easing buyers’ paths to homeownership. In some cases, the buydown option affords borrowers higher mortgage approvals, which enables builders to move inventory at their desired price points. Either way, the builders benefit from the deal, even though they may be paying to lower the interest rates up front.
“Long term, it’s being built into the price of the home,” Pierce said. “But it makes it very attractive for someone who’s concerned about payment shock.”
Simply put, “the builder is giving the buydown for their benefit, not for your benefit,” said Tendayi Kapfidze, chief economist for LendingTree.
Negotiating a builder buydown mortgage
A builder buydown mortgage can provide you with the funding and flexibility to purchase your dream home. Unfortunately, the current inventory shortage gives builders the advantage. Available home inventory has hovered around 5% for the past several years, according to the Federal Reserve Bank of St. Louis, so buyers are the ones feeling the pinch right now.
But Pierce noted that as the market normalizes, builders and sellers will be more willing to offer buydowns. Even in a tight market, it’s worth asking about the buydown option. Although builders may not advertise that they’re willing to do a buydown, they may be amenable if it means they can sell their development properties faster and at better prices.
“Always ask for the builder buydown, because probably somebody within that development is getting it, and they’re getting it because they’re negotiating a harder deal,” Kapfidze said.
Here’s what you need to know about negotiating a builder buydown mortgage:
Find the right real estate agent. If you plan to buy a brand-new home from a builder, make sure your real estate agent has experience working on those types of deals, Pierce advised. Builder negotiations are a different beast than working with individual sellers, and you’ll want someone with a proven track record representing you.
Before agreeing to work with a particular agent, meet with a few potential representatives. Ask about the types of deals they typically work on and whether they have a speciality area. Someone who knows the ins and outs of builder negotiations and has relationships in the industry will be better-equipped to guide you through the buying process.
Obtain preapproval from an outside lender. Builders may want you to apply for loan approval through their preferred lenders, but Pierce recommended seeking preapproval from an outside firm as well. Lenders affiliated with particular building companies may put the builders’ interests ahead of yours, and having an outside perspective could help you avoid overpaying. You may still close with the builder’s preferred lender, but you’ll know that you’re getting a fair rate.
However, because builders are motivated to sell, they may accept a deal from an outside firm to keep the sale moving quickly. Knowing that you’re preapproved bolsters their confidence that you’re a qualified buyer, and they may prioritize expediency over insisting you go through their usual partners.
Study the market and the builder’s business. Although real estate inventory is tight nationally, that may not necessarily be true of the region in which you want to buy, Kapfidze said. He suggested studying trends in the local market to gauge your builder’s position — perhaps you’re looking in the Midwest, which may be less constrained than the Bay Area, for example. Depending on your market conditions, you may have more leverage than you realize.
Kapfidze recommended getting to know your builder’s business as well. If it’s a publicly traded company, you can listen to its quarterly earnings calls or read earnings releases and find out what they’re prioritizing this year. Are they eager to move more housing units? Are their sales numbers down? While listening to earnings calls may seem extreme when you’re simply trying to buy a new home, that information can be incredibly useful in a negotiation.
“You almost want to follow their stock as if you own the stock, and understand where their pain points are and where they might be vulnerable for you to put the squeeze on them a little bit,” Kapfidze said.
The bottom line
Builder buydown mortgages offer benefits to both builders and buyers. But how much benefit you gain depends largely on how well-versed you are in your own financial circumstances, your local market conditions and your builder’s business. A buydown mortgage can get you into the home you want with the financial buffer you need. The key to making it work is being clear about what you can afford and arming yourself with the right information in your negotiations.