The second half of 2022 saw the red-hot U.S. housing market thrust into an abrupt—and sharp—slowdown. That will happen when mortgage rates spike from 3% to 6% just after U.S. home prices skyrocketed over 40% during the Pandemic Housing Boom.
Unlike existing-home sellers who can just wait out the storm, U.S. homebuilders—who have a historic number of units in their backlog—have no choice but to sweeten the deal for new buyers in 2023. Their incentive of choice? Aggressive mortgage rate buydowns.
How do mortgage rate buydowns work? Essentially, builders pay lenders a lump sum of money in order to reduce mortgage rates for prospective buyers. For example, a builder might offer a 2-1 rate buydown, in which the mortgage rate is reduced from, say, 6% to 4%, and based on the agreement, the rate would increase each year after by one percentage point until it reaches 6%.
“If you look back over time, there’s different incentives that work during different periods of time. The reason that rate buydown is working right now is because rates got so high,” Devyn Bachman, senior vice president of research at John Burns Real Estate Consulting, told Fortune. “It’s always been a thing. It’s just that it’s the popular choice in today’s market.”
Although the 2-1 temporary rate buydown is frequently used to make an offer more enticing, Bachman said consumers are favoring full-term buydowns. That means they’re “buying down the rate for the entirety of that person’s mortgage,” Bachman said.
As of last month, 75% of nationally surveyed homebuilders said they’re buying down buyers’ mortgage rates to make payments more affordable, according to John Burns Real Estate Consulting. That same survey found 32% of builders are buying down the full 30-year term, while 30% are only temporarily reducing the rate for the first two years.
Bachman told Fortune that large incentives bolstered by rate buydowns are encouraging more consumers to consider purchasing new homes versus existing homes because the resale market can’t compete with those offers.
The company’s latest builder survey found new-home sales rose 11% from November to December, she said. And although there are several factors at play, the incentive of rate buydowns does carry some weight in deciphering the improvement.
“There’s lots of factors at play, but the rate buydowns and the size of them is definitely one of the levers that’s encouraging consumers to purchase new homes,” Bachman said.
As for the cost of mortgage rate buydowns for builders, each 0.25% reduction in the rate typically costs around 1% of the loan amount. But with the market barely beginning to see signs of depressurization, it’s often the only incentive builders can offer buyers to push the sale through.
Still, the cost of the rate buydown varies and is dependent on a few factors, which include home price and down payment—which in itself varies based on the market being affordable or unaffordable—the type of loan, and the type of buydown.
