Do Home Builders Need to Provide Real Estate Value to Make the Calculations Work?
If you’ve been shopping for a home since the start of 2022 when mortgage rates rose dramatically, you may have come across a bargain.
A buydown is used to lower the home buyer’s mortgage rate, either temporarily or permanently.
It can make the loan payment cheaper for the first few years of the loan term, or for the entire 30 years.
These purchases act as an incentive to buy a home, even if interest rates and home prices are high.
And homebuilders are all over it, in part because they don’t want to lower their prices. And maybe because the need giving them to move the product.
Measure Purchases Are Good, But May Not Be Necessary
As already mentioned, home builders are big on buying mortgages, offering them in earnest as the 30-year fixed rate began to rise rapidly in early 2022.
Prior to the spring of 2022, mortgage rates were near record lows, but when the Fed ended its mortgage-backed securities (MBS) purchase program known as QE and began raising the fed funds rate, conditions quickly changed.
The fixed 30-year was in 3 years starting in 2022, and quickly increased to about 6% in the same summer.
It eventually rose to 8% before retreating to the 6s.
Meanwhile, home prices have continued to rise, albeit at a slower pace than before. This is easily accessible, but home builders are not in the business of lowering their prices.
And they can’t live in their inventory as individuals. They need to move their inventory.
To solve this problem, they deal with the mortgage rate. They do this by offering mortgage rates for purchases.
Major homebuilders such as Lennar and DR Horton rely heavily on them through their in-house lenders, Lennar Mortgage and DHI Mortgage.
For example, if the 30-year fixed rate was 7%, they could offer to buy the first few years to make it more exciting.
A regular 3-2-1 purchase offers a 3% lower interest rate in the first year, 2% lower in the second year, and 1% lower in the third year.
This means 4%, 5%, 6%, and finally 7% for the remaining term of the loan. While this might appeal to home buyers who couldn’t afford the 7% rate, there was a catch.
Borrowers still need to qualify for the loan at the original value of the note, in my previous example 7%.
In other words, if a borrower can’t really afford a home with a 7% mortgage, using the borrower’s maximum DTI calculations, they can’t afford the property.
Therefore, the builders had to be more aggressive and ensure that the level of notes is very low, not just the level of snippets in 1-3 years.
Many Builders Offer Combined Temporary and Permanent Rate Purchases
While short-term mortgage savings are a great incentive to buy a home, they are just that.
If you want to qualify for more home buyers, you need to reduce the amount of the note throughout the life of the loan.
This rating is what banks and mortgage lenders use to qualify for home purchases. Simply put, they cannot use the existing rate for only a few years.
That could put the borrower in a pickle if the rate rises back to the original, higher rate.
So they qualify for the original loan amount, which is similar to short-term variable rate loans, which may adjust higher once the initial term is over.
Knowing this, home builders have started offering temporary/permanent combo purchases to address both the affordability piece and the incentive piece.
Using my same example from above, the builder would probably offer a 2/1 purchase instead of a permanent attached purchase.
For example:
Year 1: 3.875% rate.
Year 2: 4.875% rate.
3-30 years: rate of 5.875%.
Now, the lender can get the borrower at a rate of 5.875%, as the highest rate that will go during the whole 30 years of the loan.
And that can be the difference between a mortgage being approved and being denied.
Lenders are required to use the Note Rate for Mortgage Qualification
Note that both Fannie Mae and Freddie Mac require lenders to qualify the borrower for the value of the note.
In the case of a foreclosure, “the lender must qualify the borrower based on the value of the note without regard to the purchase price,” according to Fannie Mae.
If it’s a permanent purchase, “eligibility is based on the average monthly income expense calculated using the monthly payment on the purchased permanent note,” according to Freddie Mac.
This may explain why many of the major home builders today offer temporary AND permanent buyouts.
They create interest for consumers at a low temporary rate, and ensure they qualify for a loan at a permanently discounted rate.
In this process, they can continue to present their inventory and ensure that prices do not fall, despite reducing accessibility.
Homebuilders continue to win despite those 7% mortgage rates. And no doubt home buyers get a decent payout.
Just pay attention to that purchase price when buying a newly built home to make sure the low price isn’t baked in.
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