Buydowns also reduce early repayment risk to mortgage lenders. If you starting at a rate below market rates need to go down a lot before you can refinance.
Put another way, there is implicit option value in a market based mortgage rate which is being consumed into an explicit reduction in the monthly payment requirement upfront.
Isn't it as simple as "Offering a discount, without lowering comps," (where "Comps" refers to "comparable sales")? A buydown is just a discount that doesn't show up in the sales price.
The steady increase or not-decrease of headline home prices--driven by comps--is the #1 thing that gives people the confidence to buy a home. They don't want to buy "too high." In general, pretty much everyone is invested in the preservation of home equity value . . . lenders, agents, builders, homeowners, electeds.
I've written a lot about this (and was very early on the homebuilder trade, fwiw . . . it was a good trade):
I think you’re right. At the link, I propose 2 reasons for the popularity of rate but downs. First, the decline in costs creates the temporary motivation to use incentives, as you describe. Second, rate buydowns lower the prepayment risk to the lender, creating more profit in the transaction than a simple discount or incentive would.
There are endless Lennar neighborhoods in my region that were built as instant slums. It is difficult for me to attribute to the buyers of these homes, even the level of sophistication you're speaking of. And I do believe there are houses built here in the past three decades, that have appreciated about as well as a car you drive off the lot.
Lennar generally sells up market? What region are you referring to? I don't think I'm attributing any particular sophistication to anyone. Retailers don't like discounts. They'd rather lower prices in ways that don't show up in the sticker price. That's especially true of houses, which are both an asset and a commodity. The interesting dynamic here is that institutional builders ("retailers") comprise a relatively small (but growing) share of the market--as retailers, they can offer discounts because volume is more important than margin (and margins are fat). Homeowners, however, are not retailers. They are asset-holders, and they don't want to give any discounts at all.
Good explainer for those of us who are Super Boring with Money. I hadn't even heard of the role of particular mortgage schemes in 2008. The derivatives, sure, and the ill-vetted borrowers. But I never did really read a post-mortem about it. Oddly, I did read "Liar's Poker". These maddening things go down easier after some time has passed.
Typical - as with everything that's the matter with this country, it was a joint production of left and right, the left's desire for everyone, in the name of equality, to own a home without reference to reality, joyfully abetted by the right's desire to figure out as many novel ways to make money that can't actually work, and actively harm the country, as possible.
These schemes Arnold described are convoluted to my mind, which probably means the direct approach, just offering the buyer an after-purchase rebate on the home is illegal?
Most of that explanation is beyond my comprehension. Here is what seems correct.
- the buyer pays a premium price for the house so the builder will buy points that don't cost as much as the premium.
- if the buyer sells early in the mortgage, the mortgage will be nearly $5,000 larger and net proceeds that much less. Buyer loses.
- if the buyer stays in the home the life of the loan, both builder AND the buyer come out ahead so the lender must be losing in that case. (Points are priced assuming mortgage will be retired early and lender always loses, relative to no points, if the loan goes full term.)
- Arguably, the house isn't worth $105,000 so if the loan has a minimum down payment, the buyer isn't meeting it if the appraisal is $100,000. These things are frequently fudged a few percent though.
Frankly, I think you are giving lenders undeserved credit for believing in good faith that most borrowers will be able to pay off their mortgages.
People, especially lenders (and investors in securitized mortgages), speak of a borrower's credit history as if it were the main or only factor that determines whether or not a borrower will default, but that is ridiculous. Business cycles happen, and therefore, pretty much everyone's ability to make the payments will almost certainly be taken away from them for several months, some time during the life of their mortgage.
It is self-evident to me that an honest lender, therefore, would write a contract that allows for a suspension of the obligation when the borrower (or either of the borrowing couple) is involuntarily unemployed.
(And yes, I've heard the econ argument that involuntary unemployment doesn't exist. Horse hockey.)
As it stands, the borrower is reduced to begging for such an arrangement after the disaster occurs, from a lender who likely finds it more profitable to foreclose. That is not just unfair -- it was predictable at the original signing, which means that most mortgages are acts of fraud by the lender. This holds true all the more when the lender is writing the loan to sell it rather than to hold it.
Just thinking about this some more, I wonder how the regulators look at this, as I would think the official sales price is probably inflated, to fund the buy-down. If the appraised value equals the sales price, wouldn't this overstate the down payment? Maybe the lender adjusts for this, but maybe not.
Interesting. I assume the "buy-down" is easier to set up for newly built homes, as the builder can facilitate this by inserting itself into the buyer/lender equation. Would be more difficult to do this for existing homes, post 2008, as there is no 3rd party to do the "buy-down", and the regulators don't want the banks to do it.
Of course other costs are rising as well with inflation and that might be the deal stopper regardless of a buy-down. Some do look at their overall monthly "nut".
Buydowns also reduce early repayment risk to mortgage lenders. If you starting at a rate below market rates need to go down a lot before you can refinance.
Put another way, there is implicit option value in a market based mortgage rate which is being consumed into an explicit reduction in the monthly payment requirement upfront.
This is the point I made in the post Arnold linked to.
If there wasn't a pre-payment valuation issue, the discounted home price vs rate buydown would have the same monthly payments.
Isn't it as simple as "Offering a discount, without lowering comps," (where "Comps" refers to "comparable sales")? A buydown is just a discount that doesn't show up in the sales price.
The steady increase or not-decrease of headline home prices--driven by comps--is the #1 thing that gives people the confidence to buy a home. They don't want to buy "too high." In general, pretty much everyone is invested in the preservation of home equity value . . . lenders, agents, builders, homeowners, electeds.
I've written a lot about this (and was very early on the homebuilder trade, fwiw . . . it was a good trade):
https://www.therandomwalk.co/i/131985115/new-homes-old-homes
https://www.therandomwalk.co/i/129484321/is-it-really-game-on-for-homebuilders
https://www.therandomwalk.co/i/135276067/homebuilders-on-the-march-reprise
I think you’re right. At the link, I propose 2 reasons for the popularity of rate but downs. First, the decline in costs creates the temporary motivation to use incentives, as you describe. Second, rate buydowns lower the prepayment risk to the lender, creating more profit in the transaction than a simple discount or incentive would.
There are endless Lennar neighborhoods in my region that were built as instant slums. It is difficult for me to attribute to the buyers of these homes, even the level of sophistication you're speaking of. And I do believe there are houses built here in the past three decades, that have appreciated about as well as a car you drive off the lot.
Lennar generally sells up market? What region are you referring to? I don't think I'm attributing any particular sophistication to anyone. Retailers don't like discounts. They'd rather lower prices in ways that don't show up in the sticker price. That's especially true of houses, which are both an asset and a commodity. The interesting dynamic here is that institutional builders ("retailers") comprise a relatively small (but growing) share of the market--as retailers, they can offer discounts because volume is more important than margin (and margins are fat). Homeowners, however, are not retailers. They are asset-holders, and they don't want to give any discounts at all.
I'm thinking of places I see all the time, from the interstate - but specifically a street I found myself on the other day - here's a typical dwelling: https://www.trulia.com/p/tx/san-antonio/1923-skull-valley-dr-san-antonio-tx-78245--2071196924
This is post-real estate-frenzy. That frenzy affected nearly all areas of Texas. Well, you might say, San Antonio is different. Why different.
Good explainer for those of us who are Super Boring with Money. I hadn't even heard of the role of particular mortgage schemes in 2008. The derivatives, sure, and the ill-vetted borrowers. But I never did really read a post-mortem about it. Oddly, I did read "Liar's Poker". These maddening things go down easier after some time has passed.
Typical - as with everything that's the matter with this country, it was a joint production of left and right, the left's desire for everyone, in the name of equality, to own a home without reference to reality, joyfully abetted by the right's desire to figure out as many novel ways to make money that can't actually work, and actively harm the country, as possible.
These schemes Arnold described are convoluted to my mind, which probably means the direct approach, just offering the buyer an after-purchase rebate on the home is illegal?
And Moses below beat me to it.
Also, no builder wants future potential customers to see a previously tagged $500K house sold for $450K.
Isn't the Fed doing a form of bond-holder buy down, thru inflating the collateral value of their prior (too-) low interest T-bills?
Most of that explanation is beyond my comprehension. Here is what seems correct.
- the buyer pays a premium price for the house so the builder will buy points that don't cost as much as the premium.
- if the buyer sells early in the mortgage, the mortgage will be nearly $5,000 larger and net proceeds that much less. Buyer loses.
- if the buyer stays in the home the life of the loan, both builder AND the buyer come out ahead so the lender must be losing in that case. (Points are priced assuming mortgage will be retired early and lender always loses, relative to no points, if the loan goes full term.)
- Arguably, the house isn't worth $105,000 so if the loan has a minimum down payment, the buyer isn't meeting it if the appraisal is $100,000. These things are frequently fudged a few percent though.
Frankly, I think you are giving lenders undeserved credit for believing in good faith that most borrowers will be able to pay off their mortgages.
People, especially lenders (and investors in securitized mortgages), speak of a borrower's credit history as if it were the main or only factor that determines whether or not a borrower will default, but that is ridiculous. Business cycles happen, and therefore, pretty much everyone's ability to make the payments will almost certainly be taken away from them for several months, some time during the life of their mortgage.
It is self-evident to me that an honest lender, therefore, would write a contract that allows for a suspension of the obligation when the borrower (or either of the borrowing couple) is involuntarily unemployed.
(And yes, I've heard the econ argument that involuntary unemployment doesn't exist. Horse hockey.)
As it stands, the borrower is reduced to begging for such an arrangement after the disaster occurs, from a lender who likely finds it more profitable to foreclose. That is not just unfair -- it was predictable at the original signing, which means that most mortgages are acts of fraud by the lender. This holds true all the more when the lender is writing the loan to sell it rather than to hold it.
Just thinking about this some more, I wonder how the regulators look at this, as I would think the official sales price is probably inflated, to fund the buy-down. If the appraised value equals the sales price, wouldn't this overstate the down payment? Maybe the lender adjusts for this, but maybe not.
Interesting. I assume the "buy-down" is easier to set up for newly built homes, as the builder can facilitate this by inserting itself into the buyer/lender equation. Would be more difficult to do this for existing homes, post 2008, as there is no 3rd party to do the "buy-down", and the regulators don't want the banks to do it.
Of course other costs are rising as well with inflation and that might be the deal stopper regardless of a buy-down. Some do look at their overall monthly "nut".