High interest rates, coupled with a still-low supply of housing, have created price hurdles that are keeping many first-time homebuyers and lower-income borrowers locked out of the housing market.
Interest rates, though down slightly in recent weeks, are still double what they were at the end of 2021, and the Federal Reserve continues its monetary tightening policies to fight inflation.
Rob Nunziata, co-CEO and co-founder of Florida-based FBC Mortgage, says one mortgage sweetener that holds out some promise for making houses more affordable for a broader swath of borrowers is the temporary rate buydown.
“It is really a great tool from a seller perspective to say, ‘Look, we don’t control rates, but what I can offer you is something that will offset this shock in interest rates that has happened here in the last nine or 10 months or so,’” Nunziata said.
FBC Mortgage recorded originations of about $8 billion in 2022, including its joint venture volume, Nunziata said, adding that about 70% of that volume “was new construction.”
Most of the temporary rate buydowns offered through FBC are paid for by builders, he said.
“We do a lot of buydowns, so we’re in the thick of buydowns right now,” Nunziata said. “Nobody was doing buydowns in 2020 and 2021 [when 30-year fixed mortgage rates were in the 3% range].
“They are a very underutilized product,” Nunziata added, “but I think they’re a great product. A lot of FHA [Federal Housing Administration] borrowers and VA [Veterans Affairs] borrowers are doing the buydowns, but we also see it popular with conventional borrowers as well.”
Nunziata said “probably 80%” of the temporary rate buydowns that FBC Mortgage handles are 2-1 buydowns — which means the mortgage rate steps up from an original discounted rate over the course of two years and returns to the non-discounted rate in the third year. The National Association of Home Builders reports that 27% of builders report using temporary rate buydowns as a home-purchase incentive.
For example, in a 2-1 buydown, the rate may start at 4.2% in year one, go to 5.2% in year two and return to the non-discounted rate of 6.2% in year three. Other variations of the temporary buydown exist, such as a 3-2-1 buydown, in which a discounted rate is in place for three years.
“It varies a little bit based on loan amount and interest rate but … a pretty good rule of thumb is a [2-1] buydown will typically cost the seller about 2.25 percentage points of the loan amount,” Nunziata said. He added that for younger first-time homebuyers who expect their earnings to increase as their careers unfold, the temporary rate buydown can be a much better entry point into the housing market.
Nunziata explained that offering prospective homebuyers a $10,000 discount off the sales price of a $400,000 home, for example, will save the buyer about $60 a month on his or her mortgage payment.
“So, if you take that same $10,000 and you apply it to a temporary rate buydown, the first year of that buydown, you’ll save $489 a month as opposed to $60 a month,” he said. “The second year you’re going to save $250 a month as opposed to $60.
“You can see that’s a really big impact for that first-time buyer, giving them the ability to kind of ease into that payment.”
The rate of home-price growth ticked down slightly again in November, with the just-released S&P CoreLogic Case-Shiller National Home Price Index showing annualized gain of 7.7% in November, down from a 9.2% annual rate of growth in October. So, while the rate of home-price gains is trending downward, home values are still appreciating overall.
The National Association of Realtors (NAR) reports that existing-home sales dropped 17.8% in 2022, the weakest showing since 2014.
“With home values quickly appreciating, interest rates now at their highest levels in over 10 years and record low for-sale inventory this spring, these are not the most favorable conditions for prospective buyers, to say the least,” said Zillow economic-data analyst Dan Handy. “… Changes in inventory and affordability will remain key to the housing decisions of prospective buyers in the months ahead.”
Miki Adams, president of CBC Mortgage Agency, a nationally chartered housing-finance agency, said it’s also important to note that the benefits of temporary rate buydown loans [TRBLs] can be amplified if used “in conjunction with” other down payment assistance programs. CBC Mortgage does not offer a temporary rate buydown program, but it is focused on offering down payment assistance for first-time homebuyers by providing them with second mortgages issued in tandem with FHA-insured loans.
“Certainly, I believe minorities could benefit greatly from rate buydowns as mortgage rates remain elevated, as could any family, regardless of their ethnicity or income range,” Adams said.
In terms of acceptance in the secondary market of these TRBLs, which is key to ensuring lender liquidity, the jury is still out. However, because existing mortgage rules require that TRBLs be underwritten at the non-discounted note rate, they are likely to perform similarly to non-discounted mortgages, market observers say — with some caveats.
Ginnie Mae backs bonds issued against securitized loan pools insured at the loan level through government agencies such as the FHA and VA. Adams said Ginnie Mae limits the percentage of TRBLs that can be part of loan pools serving as collateral for securitization transactions.
“GNMA allows for 10 percent of the balance of either a custom or multi-lender [loan] pool to be buydown loans,” Adams explained. “While custom buydown pools are allowed, they typically trade back from standard multi-lender pools.
“Since that is the case, there is risk involved if buydowns exceed 10 percent of your GNMA production, so the concentration of buydowns in your pipeline should be monitored closely.”
Roelof Slump, managing director of structured finance operational risk at Fitch Ratings, said that so far, not very many of the temporary rate buydown loans (TRBLs) have found their way into the private-label securitizations that Fitch rates. John Toohig, head of whole-loan trading at Raymond James in Memphis, likewise said it’s difficult to say how these TRBLs will perform in the whole-loan trading market because it’s simply too soon to know.
“The [TRBL] borrower arguably, if the loan is underwritten correctly, would be able to make the payments on a higher rate [when it kicks in a few years later],” Slump said. “They [TRBL borrowers] are probably going to behave similarly to other mortgages [including with respect to refinancing decisions] after their [rate] reset, if I can call it that.
“That would not impact our rate analysis. …To the extent that there is rapid refinances [within a particular collateral pool backing a TRBL securitization], that could … result in rating [changes] if the transactions are prepaying much more quickly than was expected, but I think that’s more of a timing issue than a substantially different sort of performance.”
Although they are not a new concept, TRBLs have only recently been re-introduced to the market, with a number of nonbank lenders unveiling rate buydown offerings this past year as 30-year fixed rates tipped over 7% in November 2022. Among the lenders that offer TRBL programs, in addition to FBC Mortgage, are Guild Mortgage, NewRez, Rocket Mortgage, loanDepot and United Wholesale Mortgage.
Michael Neal, principal research associate at the Urban Institute’s Housing Finance Policy Center, said research shows that rate buydowns that are longer-term, or even permanent, coupled with other down payment assistance, can help homeowners build equity, and consequently wealth, faster. In addition, he said rate buydown loans, used appropriately, can open the door to increased homeownership among first-time homebuyers and historically marginalized groups, such as African Americans.
The U.S. Census Bureau recently released figures for the fourth quarter of 2022 showing the extreme disparity between Black and white homeownership — 44.9% and 74.5%, respectively.
“We saw what happened [after] the housing bust [some 15 years ago] when we boosted homeownership for households of color, but it was not sustainable,” Neal said.
Neal pointed to a government-subsidized rate buydown program launched in the 1970s, another period of high interest rates. Through that rate buydown program, lenders made loans at below-market rates that were then purchased by Ginnie Mae, which subsidized any loss on those loans after they were resold at market prices to Fannie Mae or Freddie Mac.
In a research report co-authored with his Urban Institute colleague Daniel Pang, Neal suggests that a similar government-sponsored permanent rate buydown program could be re-introduced today to “improve affordability, close racial wealth gaps in housing, and better insulate historically marginalized communities from macroeconomic shocks.”
Neal stresses, however, that such a program should not take a shotgun approach, but rather be specifically targeted — suggesting that it might be aimed at residences in neighborhoods of color, first-generation homebuyers and/or local public employees, for example.
“Anything that the government can do to help people afford a house payment or down payment more easily amid soaring interest rates and sky-high home prices would be welcomed,” Adams said.
Neal said such a government-sponsored long-term rate buydown program also could be good for the housing industry as well.
“From the industry perspective, it’s possible that your operations ebb and flow with [the mortgage] cycle, but the degree to which you’re able to smooth that out a little bit with an interest-rate buydown program, you may bring a few more people into the market that otherwise wouldn’t buy a home,” Neal said. “… And certainly, closing the racial gaps in homeownership is a critical piece.”
Ben Hunsaker, a portfolio manager focused on securitized credit for California-based Beach Point Capital Management, said a proposal for a new government-subsidized rate buydown program might be a popular idea in concept, but added that it is not likely to gain much traction at this moment in time.
“People pay a lot of attention to delinquency rates and FHA loans,” he said. “If we didn’t have trailing 30-days [delinquency rates] starting to tick up for FHA loans, I would say, ‘Hey, this is something that HUD [the Department of Housing and Urban Development, under which Ginnie Mae is housed] is probably going to be all over.’”
”I think there’s potentially political will to have targeted programs to increase homeownership,” Hunsaker added, “… but I think it’s harder to see support [for a government-subsidized rate buydown program] now.”