- Mortgage rate buydowns are a home financing tool that provides buyers with a lower interest rate.
- Homebuilders are employing rate buydowns the most in areas where home prices are falling the fastest.
Homebuilders are using creative incentives to attract individual homebuyers as high mortgage interest rates continue to eat away at demand for new homes.
A prevalent trend that builders are leaning into in order to help them sell more homes amid an increasingly tough economic climate is paying for mortgage rate buydowns for prospective buyers. A rate buydown is an upfront payment for "discount points" at closing to reduce the rate on a fixed-rate mortgage term. While it can cost thousands of dollars upfront, the idea is that it will save buyers more money over the life of the loan.
According to new research from John Burns Real Estate Consulting, more than 75% of homebuyers nationwide are using mortgage buydowns to attract more homebuyers. Almost one-third of homebuilders surveyed said they are buying down the full 30-year mortgage for their buyers, which can lower mortgage rates by up to 2% and save average homebuyers thousands of dollars in fees over the period of the loan.
This would mean that on a median home in a city like Phoenix, which Realtor.com says costs nearly $450,000, homebuilders are fronting between $22,500 and $27,000 to reduce their buyer's mortgage by 1% or 2% from the current average rate of 6.33%.
"We've been having a lot of conversations with homebuilders about what incentives are particularly effective at attracting new homebuyers, and we're finding that the rate buydown aspect really matters in terms of attracting new buyers in a slow market," Jody Kahn, senior vice president of research at John Burns told Insider.
Concessions and incentives help builders remain competitive in uncertain times
Of course, builders are trying other incentives or promotions to help sweeten the deal for buyers. Recently, Lennar Homes, one of the largest builders in the US, tried holding a Black Friday-esque sale promotion to attract new buyers. Other companies, like Taylor Morrison, are offering discounts between $18,000 and $50,000 in hopes of attracting buyers to its homes in Houston, Texas. And then other builders are offering free or reduced upgrades for finishes or appliance packages to help get homes under contract.
These companies are utilizing concessions to offload homes at a time when rising mortgage rates and stubborn inflation have caused many homebuyers to sit on the sidelines and wait for the market to shift in their favor. For instance, Redfin's Homebuyer Demand Index, which measures the volume of home tours and other buying-related activity, shows that homebuyer demand was down approximately 20% in early December 2022 compared to the same period last year.
And with how much mortgage rates and sale prices have fluctuated over the last six months, many buyers have opted to cancel contracts on new construction homes — which typically take several months to complete — as a means of mitigating risk in the uncertain environment.
The low demand for homes has become especially pernicious as homebuilders face economic headwinds from rising labor and material costs to the deteriorating health of capital markets, which has made it more costly to borrow money from banks. Meanwhile, housing supply continues to tick upward as homebuilders sit on thousands of unsold homes.
"Homebuyer incentives are becoming much more important given that we're living through a time of much weaker affordability because of rising home prices and interest rates, both of which have effectively priced out many homebuyers and especially first-time buyers," Khan further explained.
Homebuilders take a regional approach to mortgage buydown incentives
Despite how prevalent the trend is, more homebuilders are deploying mortgage buydown incentives in areas where home prices are falling fastest.
For instance, data from John Burns Real Estate Consulting shows that more than 87% of homebuilders across the Southwest are using buydowns as a way to attract new buyers. This comes at a time when home prices have fallen by 10% or more in cities such as Phoenix, San Diego, and Las Vegas.
Taylor Morrison, which is headquartered in Phoenix, Arizona, is one of the homebuilders employing buydowns across the southwest. The company is offering what's known as a 2-1 buydown where a buyer's mortgage rate is decreased by 2% during their first year and 1% in their second year before returning to a fixed rate for the remaining duration of the loan. The incentive extends to both conventional and FHA mortgage borrowers with a minimum credit score of 680, according to the company's website.
The tactic seems to be paying dividends as the company's cancellation rate has remained steady at around 4% compared to its historical average of nearly 7%, Sheryl Palmer, Taylor Morrison's CEO, told investors during the company's Q3 earnings call in October.
"We strongly believe in the value of using finance as a sales tool by offering generous market incentives versus simply reducing price as the benefits to the buyer is often much greater," Palmer said.