Why are rates rising, and is there a light at the end of this tunnel?
By now, you have heard of or come face to face with the slowing real estate environment. The culprit is inflation, born of a post-pandemic fiscal stimulus intended to help the American economy recover. The unintended consequence was a 40% increase in the money supply of the U.S. economy. It also provided “seed money” for people and businesses to buy real estate like never before. The extra money brought about a rise in purchases in the suburbs, international cities, rural areas, lakefront properties, sunshine states, second homes, and investment properties.
The rest of the world’s economies basically followed suit, adding too much money to their respective economies and thereby ushering in the classic inflation scenario: too much money chasing too few goods and services.
We have also heard of “global supply chain dislocation.” It is a fact that the combination of China’s (the 2nd largest economy and maker of low cost goods in the world) slowdown due to severe COVID lockdown restrictions and the Russia-Ukraine war, which reduced supplies of petrol and food throughout the European nations and beyond, have contributed to an increase in the cost of many goods and services pertaining to U.S. imports. What happens around the world in a global economy affects us all.
On a national and local basis, there have been property shortages for years due to insufficient construction of affordable housing since the onset of the 2008 financial collapse. This had only worsened during the pandemic years.
The inflationary recovery (excess money), low supply of goods, and the housing shortage have created the perfect storm.
The Federal Reserve, using its limited tools, is trying to reduce inflation by tamping down demand. They do this by increasing short-term federal fund rates that directly influence the prime rate for consumers, thus affecting credit cards, home equity lines of credit, and other short-term borrowing facilities.
Additionally, on the long end, the Fed has tapered the purchase of mortgage-backed securities which had helped keep long-term mortgage rates low during the pandemic. These two items particularly conspire to slow down the hot Real Estate market in particular.
Lenders are trying to combat the rising interest rates with various programs to help potential homebuyers in the marketplace, utilizing products such as adjustable-rate mortgages (ARMs), first-time home buyer programs, affordable housing products, grant programs, etc. In addition, national agencies Fannie Mae and Freddie Mac have recently removed loan-level pricing adjustments for many of their low down payment programs in an effort to lower the cost of home ownership.
However, there is one unique product that may help both buyers and sellers come to terms with a solution to a (hopefully) temporary condition. This product is known as a temporary buydown.
We will use an example scenario here to show how this product can be used to help both buyers and sellers, as well as provide a few details as to what is required:
A buyer is seeking to buy a home in the range of $650,000, but the cost of purchasing that home has increased in the past four months by 30% or more due to higher mortgage rates. The original rate three months ago was 4.875%, while the current rate is 6.875%. This has caused the buyer to refrain from making full-price offers.
A seller has placed a property for sale at $650,000 that has been met with a tepid response in the preceding week(s) with no offers to date. The listing agent is considering having an uncomfortable discussion with the seller, requesting a reduction in the price by $30,000 – $40,000 before the rates rise too much more.
The Temporary Buydown Solution:
The listing agent suggests that rather than reducing the price of the property from 5% ($32,500) to 6% ($39,000), why not offer a 3% ($19,500) seller concession to the buyer instead and advertise it in the MLS?
The buyer’s agent is in full agreement and informs the buyers to speak with their loan representative, who may be able to explain this product and provide a 2-1 buydown solution.
Assuming there’s a 20% down payment, the loan amount would be $520,000. At a 6.875% interest rate, the monthly payment would be $3,416. Based on a current rate of 6.875%, the temporary buydown works as follows:
- Year 1 – The payment will be 2% below the fixed rate or 4.875% ($2,751)
- Year 2 – The payment will be 1% below the fixed rate or 5.875% ($3,076)
- Years 3-30 – The rate would be 6.875% or $3,416/month for the remainder of the term
(Monthly Savings of $665) x (12 Months) = Annual Savings of $7,980
(Monthly Savings $340) x (12 Months) = Annual Savings of $4,080
Total Savings = $12,060
$12,060/$520,000 = 2.32 points
The seller would provide the points above. Any additional amount could be used to pay other qualified closing costs. Let’s take a closer look at the benefits to both parties:
- Marketing tool for the seller’s property
- Differentiates the property
- Less expensive than a price reduction
- Attracts more qualified buyers
- Sell property before property values possibly decline further
- Reduce the monthly carrying cost
- Lower payment for the first 2 years
- Reduce payment shock
- In the event of a payoff/refinance, the unused subsidy account* reduces the payoff amount.
- *An escrow account is set up to hold the buydown points administered by the servicer of the loan and supplements the monthly payments made by the buyer.
- The property must appraise at the contract sales price; otherwise, some or all of the seller concessions could be negated.
- Buydown must be funded by the seller.
- Available on Conforming, FHA, and VA loans.
- ONLY available for 1-4 family primary residences & single family second homes.
- Borrower MUST qualify for the note rate.
Like any other product, this may not apply to all scenarios but can be effectively utilized in certain situations. Let’s hope (as many economists believe) that rates will taper down in the coming months as inflation decreases and that rate stability will finally return to the marketplace.
Have a great holiday season!
Donald Arace – Divisional President of Hudson United Mortgage