Just before speaking with Fortune, Carol Walsh, a California-based real estate agent serving San Benito, Santa Cruz, and Monterey counties, was on the phone with a lender discussing how a lot of homebuyers, and in particular sidelined buyers, don’t understand that mortgage rate buydowns are even an option right now.
Mortgage rate buydowns, a financing technique in which a seller pays a lump sum of money to reduce a buyer’s interest rate for a period of time, resurfaced last year like an old tool being brought out of the box again, says Walsh, as sellers attempted to attract buyers who were scared off by spiked mortgage rates. But buyers, Walsh says, have to understand how rate buydowns work before potentially talking a seller into it.
Rate buydowns can be broken down into two categories: long-term and short-term (or temporary, as most refer to it). Long-term rate buydowns span through the entirety of the loan, Walsh says, and “are much less common because it’s so much more expensive to buy it down over the long term.” As for temporary buydowns, which also vary, a seller essentially pays a lump sum of money to reduce a buyer’s mortgage rate for just a few years. For example, a 3-2-1 rate buydown sees the seller’s credit used to reduce the buyer’s rate by 3 percentage points the first year, 2 percentage points off in the second year, and 1 percentage points off in the third year, before returning to the note rate (which the buyer has to qualify for). While for a 2-1 buydown, the seller’s credit is used to reduce the buyer’s rate by 2 percentage points the first year, and 1 percentage point in the second year, and then in the third year, the buyer pays the note rate.
Walsh said the 2-1 buydown seems to be the most common, so let’s take a closer look at how it works. Let’s say a buyer is purchasing a $600,000 home and is taking on a $480,000 mortgage at a 30-year fixed rate of 6.5% (which is close to the current market rate), their monthly payment would be roughly $3,034. However, with a 2-1 mortgage rate buydown, for the first year, their monthly payment would be around $2,432 (at a rate of 4.5%). For the second year, their monthly payment would be $2,725 (at a rate of 5.5%). That being said, the buyer is saving around $7,222 the first year and $3,702 the second year. That’s roughly $10,925 the buyer is saving—paid for by the seller.
So how exactly does a seller buy down a mortgage rate for a buyer? There are a few ways to go about it, Walsh said, but start by looking into lenders. That can mean checking out different options, like a local credit union, a local mortgage broker, and a local bank, to see what they offer as there’s “no standard across the board.” After doing so, that’s when the real challenge begins: getting the seller on board.
“It’s really important that buyers understand, this is much more likely when you’re [looking into] a house that’s been on the market for a little bit, perhaps in areas that aren’t as…desirable,” Walsh told Fortune. “You’re going to have more flexibility in being able to negotiate a credit with a seller to make this work.”
As a potential buyer, that means taking those factors, like location, into consideration and readjusting your perception of the ideal home. Still, Walsh said, there’s no “cookie cutter option” because everyone has a unique situation. That’s why it’s important to work with someone who knows the “realities of their market,” Walsh said. Nonetheless, if you were to qualify for a loan at the current rate, get the seller to agree to the credit, “then as part of a contract, [they’d] buy that rate down and lower your payment to a more comfortable level,” Walsh said.
Once a buyer has reached contract negotiations (after working with a real estate agent and lender and receiving pre-approval), they simply ask for a seller’s credit in the form of a rate buydown. The way Walsh suggests buyers do so, is by offering a seller their asking price and asking for a credit.
“Sellers are much more likely to say yes when, let’s say, the house is $700,000 and it’s been sitting on the market,” Walsh said, adding, “you’re going to get, probably, a more favorable response offering $700,000 and asking for a $20,000 credit versus just offering the seller $650,000.”
It’s important that the credit is identified in the contract as coming from the seller to buyer, so the lender can take that information and adjust the buyer’s payment, using the seller’s credit toward a rate buydown, Walsh clarified.
But here’s something to note, markets across the country are experiencing different circumstances, and within each market there’s variation among certain tiers. Buyers out West, where the housing correction has been the strongest, might have more luck getting a buydown than their peers buying in more resilient Eastern markets. Simply put: The more buyer competition for a given house, the less likely a buyer can negotiate a mortgage rate buydown.
Walsh says she’s seeing the most demand at the starter home level, so that’s where the competition is, and it’ll be harder to get a seller to agree to a rate buydown. The move-up and luxury markets, for the most part, aren’t seeing that same level of demand, so there’s a bit more flexibility in negotiating that seller’s credit, Walsh says.