Last year’s 3 percentage point increase in mortgage rates, coupled with home prices that jumped over 40% during the Pandemic Housing Boom, has priced out millions of homebuyers.
That sharp buyer pullback comes at a less than ideal time for U.S. homebuilders. See, a combination of pandemic-related supply chain constraints and a surplus of eager buyers during the boom, saw the total number of units under construction reach historic levels last year. And that historic backlog, along with spiked cancellation rates, means buyers finally have some negotiating power over builders.
To find out how buyers might be able to strike a better deal with builders, Fortune reached out to John Downs, a certified mortgage advisor and senior vice president at Vellum Mortgage.
The first trick is to simply employ raw negotiation tactics, like offering low, or using outside lenders “to keep builder lenders honest,” Downs says. The second trick is to see what incentives builders might be able to offer.
Unlike homeowners—who are less likely to give up the equity they have—builders are just dropping profit. So when the market shifts, builders can drop prices and/or throw out incentives like paying closing costs (which can amount to between 2% to 5% of your mortgage loan), offering mortgage rate buydowns (builders pay lenders a lump sum of money to reduce mortgage rates for prospective buyers), paying homeowner association dues, or making upgrades throughout the construction process.
“For builders, it’s a business,” Downs said. “Which is very different than regular homeowners where it’s their network savings. So for a builder, it’s just a raw business decision—am I still making money? And if I’m losing, what am I gaining by losing?”
Still getting builders to offer those incentives can vary depending on the market, the season, individual builders, and whether a buyer is looking to purchase standing inventory versus asking for a house to be built.
And as for individual builders, they can have different mindsets regarding inventory. For example, in the first few months of the year, one may prefer to hold onto a home until getting the price they want because there’s time. Meanwhile, another builder may be fearful of the future and offer aggressive incentives.
There’s also a clear difference between small builders and bigger builders with larger financial backing, and that can translate into the incentives they’re able to offer. Therefore as a buyer, it’s important to understand the market, the inventory, and the homebuilder you’re working with—to start, at least.
As for home improvements or upgrades, builders sometimes use the fact that “they can build stuff cheaper and the perceived value to the [buyer] is bigger,” Downs told Fortune. He gave an example: if a buyer is quoted $50,000 to build a patio but the builder could do it for $15,000—as a consumer it checks out, and the builder basically uses “inflated values to give the perception of bigger savings.”
So improvements like those, tied to the physical house, aren’t considered seller concessions by lenders. Lenders instead look at anything that is cash changing, like covering closing costs or offering rate buydowns, as a seller concession. But that doesn’t mean builders can’t still use those strategies to entice buyers—rather the buyer just needs to qualify for those incentives and that can depend on the type of loan.
However, incentives aren’t forever—it generally depends on the market, which is cyclical. There are times when builders don’t need to offer incentives (typically in a competitive market when there’s several offers over the asking price).
But Downs told Fortune that he thinks we’re in a “sweet spot of deal making,” at least for a few more months until the market rebalances and becomes more aligned with the pre-pandemic norm. Even so, affordability is still a problem, Downs said—meaning that sweet spot could potentially last a bit longer.
“When I quote payments, people still choke when they hear them,” Downs said.
You can find Zillow and Moody’s respective regional home price forecasts here.
Learn how to navigate and strengthen trust in your business with The Trust Factor, a weekly newsletter examining what leaders need to succeed. Sign up here.