Mortgage Buydowns Are Making a Comeback

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Carley Chase found her dream home in Chandler, Ariz., this summer: a three-bedroom ranch, close to work, with a pool and a backyard lined with palm trees.

Soaring interest rates threatened to put it out of reach. Her lender suggested a temporary buydown that would lower her mortgage payment for the first three years.

“I don’t think I would have been able to afford it without the buydown,” Ms. Chase said.

Rising borrowing costs have dramatically increased the cost of buying a home this year, reviving interest in mortgage products like temporary buydowns that fell out of favor after the 2008 financial crisis.

Temporary buydowns offer steep but short-term savings on mortgage rates. Borrowers get a much lower rate in the loan’s first year that gradually increases until it resets to a rate in line with market conditions at the time the loan was made.

They differ from standard buydowns, in which buyers pay an upfront fee to permanently lower the loan’s rate. And unlike adjustable-rate mortgages, the loans reset to a fixed rate.

Buyers typically don’t cover the cost of temporary buydowns. Home sellers, lenders and builders can use temporary buydowns to win over buyers concerned about high rates. They cover the difference between the actual mortgage rate and the rate the buyer pays, stashing those funds into a custodial account that the lender dips into each month.

“There have been a lot of buyers sitting on the sidelines waiting for prices to go down or rates to go down,” said D’Ann Melnick, a real-estate agent at eXp Realty in the Washington, D.C., area. “This is a way they can get rid of that payment shock a bit.”

Scores of lenders including Rocket Mortgage and United Wholesale Mortgage are touting temporary buydowns as a way to soften the blow of rates that have roughly doubled over the past year. Home builders are also using them to entice buyers. About 75% of builders surveyed in early December by John Burns Real Estate Consulting said they were paying to reduce buyers’ mortgage rates, either for the full mortgage term or for a shorter period.

At Guild Mortgage, a San Diego-based lender, mortgages with temporary buydowns accounted for less than 1% of its loan volume in the first half of the year. By November, they accounted for more than 10%.

“It’s the hottest topic,” said Shannon Heinze, a Guild Mortgage branch manager in Gilbert, Ariz.

Ms. Chase, 24, opted for what is known as a 3-2-1 buydown, which lowers the rate by 3 percentage points for the first year, 2 percentage points for the second year and 1 for the third. That cut about $450 off her monthly payment on the $430,000 home for the first year. Ms. Chase, a manager and bartender at a chain restaurant, splits the $2,550 payment with a roommate.

Her payment is set to increase annually until the buy-down period ends in 2026. She hopes to refinance to avoid the near-7% rate she locked into for the remainder of the mortgage.

Temporary buydowns have a spotty history. In the run-up to the financial crisis, lenders used them to qualify borrowers for loans they couldn’t otherwise afford. Rules implemented after the 2010 Dodd-Frank law require borrowers to qualify for the highest mortgage rate the loan will reach, rather than the temporarily lowered rate.

Borrowers who opt for temporary buydowns bet they will either be able to refinance at the end of the term or that their incomes will rise enough to make the higher payment more manageable.

“You shouldn’t build a program around that assumption,” said Ted Tozer, a nonresident fellow at the Urban Institute’s Housing Finance Policy Center, who served as the president of Ginnie Mae from 2010 to 2017. “That’s the same kind of thing that happened in 2007 and 2008.”

Some borrowers might get used to the lower payment and struggle to adjust once the buydown period ends.

“Say you buy a car with that extra monthly income you have from that buydown and then all of the sudden your rates go up and you can’t afford it,” he said. “All of the sudden you start getting more and more squeezed.”

Rate buydowns have become a key tool for home builders to keep current buyers from canceling and make home purchases more affordable to prospective buyers.

Builders increased construction in 2020 and 2021 in response to a surge in demand. Now they have a large backlog of homes under construction, but demand has dropped. Publicly traded home builders tracked by Bank of America reported a 25% decline in net orders in the third quarter compared with a year earlier.

Builders often use incentives, like rate buydowns, to lower buyers’ monthly costs without cutting sticker prices. They try to avoid cutting list prices because it can prompt buyers who signed earlier contracts at higher prices to back out of their purchases, and it increases the pressure to reduce prices on comparable properties in the neighborhood.

“We’re at this point in the cycle where things may be turning, the builder is trying to push things through, the lender is trying to push things through,” said Mark Calabria, a senior adviser at the Cato Institute and a former director of the Federal Housing Finance Agency. “This is the kind of environment where in order to keep the flow going people cut corners.”

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