Temporary Interest Rate Buydowns

photo by Tobias Baur

I was quoted in This Strategy to Cut Mortgage Rates is Becoming Popular in Bay Area — but There are Pitfalls in the San Francisco Chronicle (paywall). It opens,

When first-time buyers Rachel Shatto and Randy Nelson purchased a home in Oakland in May, they negotiated an interest rate buydown that effectively lowered their mortgage rate, and thus their monthly payment, for the first two years.

Although the seller made a lump-sum payment for the short-term rate decrease at closing, they increased their purchase price to compensate for it. This temporary rate buydown left them with more cash to pay for repairs and improvements the first couple of years, Shatto said.

Both temporary buydowns, which effectively lower the rate for one to three years, and permanent ones, which reduce it for the life of the loan, have become more popular since interest rates started soaring last year.

In June, 2.8% of 30-year fixed-rate loans funded by Freddie Mac had temporary buydowns, up from near zero a year ago but down from a peak of 7.6% in December 2022, shortly after rates spiked above 7% for the first time in more than two decades. After dipping as low as 6.14% in February, they surged above 7% again in August and now stand at 7.18%.

Buydowns are most common on new homes. When rates rise, builders frequently offer temporary or permanent buydowns as one of several incentives buyers can choose from.

A survey of builders in August asked what has been the most effective way to get buyers off the sidelines. The No. 1 answer, cited by 69% of respondents, was mortgage-rate buydowns, said Ali Wolf, chief economist with Zonda, a new-home data and consulting firm that did the survey. Only 22% said price cuts.

“When they lower prices, buyers already under contract at a higher price tend to cancel their contracts and it becomes a vicious cycle,” Wolf said.

Landsea Homes is offering buydowns on select homes in select communities including the newly opened Alameda Marina. “We are only able to offer them on homes that we can deliver within 30 to 60 days,” said Josh Santos, Landsea’s Northern California division president. “I’d say 75% of our buyers in the last 60 days” chose buydowns in lieu of other incentives such as options, upgrades or homeowners association dues.

Some sellers are also offering them on existing homes that have been sitting for a while.

Whether they make sense for buyers depends on myriad factors including their overall finances, the cost versus savings, how long they plan to stay in the home, whether they spend or invest their monthly savings, who’s actually paying for them, and future interest rates, the last of which is unknowable.

Borrowers should make sure they understand how buydowns work, the potential pitfalls and other ways to save money on a mortgage.

How permanent buydowns work

A permanent rate buydown is fairly straightforward. The buyer pays fees, called discount points, to reduce the interest rate — and therefore the monthly payment — forever.

One discount point equals 1% of the loan amount. To lower the note rate by 1 percentage point, a buyer today might pay around three points to four points. This cost can vary widely depending on the day, the lender and other factors, said Westin Miller, branch manager with Pinnacle Home Loans in Santa Rosa.

To figure out how long it would take for your monthly savings to equal the points paid, divide the total upfront fee by your monthly mortgage payment (or plug the numbers into an online mortgage discount points calculator).

Suppose a buyer can permanently lower the rate on a $700,000 mortgage to 6.5% from 7.5% by paying three points, or $21,000. That would lower the monthly payment by about $470 a month.

Divide $21,000 by $470 you get 36 months, which is the breakeven point. A borrower who kept the loan for more than three years would come out ahead. The longer it was kept, the bigger the benefit.

If a buyer knew for sure that rates were coming down soon, it might be better to take the higher rate with no points and refinance when rates drop, although refinancers will generally have to pay some closing costs again.

“If you are going to sell or refinance in a few years, paying points doesn’t make sense,” said Jeff Ostrowski, a Bankrate analyst.

Some buyers get permanent buydowns because they need a lower rate to qualify for a loan, said Jason Barnes, mortgage sales supervisor with U.S. Bank in Campbell.

Buyers pay for permanent buydowns, but in a slow market they might be able to negotiate a credit from the seller at closing to help pay for it.

How temporary buydowns work

With a temporary buydown, the borrower typically takes out a 30-year fixed-rate loan but makes payments based on a lower interest rate during the first one, two or three years in exchange for a one-time payment that is deposited into an escrow account at closing.

The upfront payment is about equal to the interest savings during the discount period.

During this period, the borrower makes payments at the lower rate and the mortgage servicer draws from the account to make up the difference. At the end of the discount period, the borrower makes the full payment.

Suppose the note rate is 7.5%. With a 1/0 buydown, the buyer makes payments based on a 6.5% rate the first year and 7.5% in years two through 30.

With a 2/1 buydown the borrower pays at 5.5% the first year, 6.5% the second year and 7.5% in all remaining years.

Three-year buydowns are available but not too popular because of the steep price.

The borrower generally must qualify for the loan based on the note rate stated in the loan agreement, in this case 7.5%.

Most lenders require sellers to pay for temporary buydowns, meaning the cost comes out of their proceeds at closing. If the buyer has no choice between a true seller-paid buydown and a lower price, there’s little reason not to take the buydown.

In competitive situations, buyers might need to increase their purchase price to cover some or all of the buydown payment, in which case they’re paying for it indirectly. Here the cost/benefit analysis gets more complicated.

A real-life example

When Shatto and Nelson bought their “cute little 1927 Tudor revival” in Oakland, they took out a 30-year loan with a 2/1 buydown from LaSalle Mortgage, Shatto said. They’re paying based on a rate of 4.125% for the first year, 5.125% the second and 6.125% thereafter.

Over the first two years, the buydown will save them $15,470 in interest, which was the cost of the buydown.

Although the seller paid for the buydown, the buyers paid a higher price to compensate, said their agent Lindsay Ferlin of Red Oak Realty.

Did they make a good deal? Here’s one way to look at it.

They paid $866,000 and, with a 20% down payment, and borrowed $692,800. Had they not used a buydown and paid $15,470 less, they would have borrowed $680,424 with 20% down.

With the higher loan amount, they’d repay an extra $27,071 over 30 years — consisting of $14,695 in interest and $12,376 in principal. But during the first two years, they’d save a total of $15,470, and most people don’t keep a mortgage for 30 years.

“Outside of a few cases, this does not have a significant economic benefit for borrowers,” said David Reiss, a professor of real estate law at Brooklyn Law School. “It’s a little bit of smoke and mirrors. I don’t think it improves their financial condition other than in a few cases where you have a low income in the present and expect it to grow significantly after a couple of years.”

Bringing Housing Finance Reform over the Finish Line

photo by LarryWeisenberg

Mike Milkin at Milkin Institute Global Conference

The Milkin Institute have released Bringing Housing Finance Reform over the Finish Line. It opens,

The housing finance reform debate has once again gained momentum with the goal of those involved to move forward with bipartisan legislation in 2018 that results in a safe, sound, and enduring housing finance system.

While there is no shortage of content on the topic, two different conceptual approaches to reforming the secondary mortgage market structure are motivating legislative discussions. The first is a model in which multiple guarantor firms purchase mortgages from originators and aggregators and then bundle them into mortgage-backed securities (MBS) backed by a secondary federal guarantee that pays out only after private capital arranged by each guarantor takes considerable losses (the multiple-guarantor model). This approach incorporates several elements from the 2014 Johnson-Crapo Bill and a subsequent plan developed by the Mortgage Bankers Association. Fannie Mae and Freddie Mac—the government-sponsored enterprises (GSEs)—would continue as guarantors, but would face new competition and would no longer enjoy a government guarantee of their corporate debt or other government privileges and protections.

The second housing finance reform plan is based on a multiple-issuer, insurance-based model originally proposed by Ed DeMarco and Michael Bright at the Milken Institute, and builds on the existing Ginnie Mae system (the DeMarco/Bright model). In this model, Ginnie Mae would provide a full faith and credit wrap on MBS issued by approved issuers and backed by loan pools that are credit-enhanced either by (i) a government program such as the Federal Housing Administration (FHA) or U.S. Department of Veterans Affairs (VA), or (ii) Federal Housing Finance Agency (FHFA)- approved private credit enhancers that arrange for the required amounts of private capital to take on housing credit risk ahead of the government guarantee. Fannie Mae and Freddie Mac would be passed through receivership and reconstituted as credit enhancement entities mutually owned by their seller/servicers.

While the multiple guarantor and DeMarco/Bright models differ in many ways, they share important common features; both address key elements of housing finance reform that any effective legislation must embrace. In the remainder of this paper, we first identify these key reform elements. We then assess some common features of the two models that satisfy or advance these elements. The final section delves more deeply into the operational challenges of translating into legislative language specific reform elements that are shared by or unique to one of the two models. Getting housing finance reform right requires staying true to high-level critical reform elements while ensuring that technical legislative requirements make economic and operational sense.  (2-3, footnotes omitted)

The report does a good job of outlining areas of broad (not universal, just broad) agreement on housing finance reform, including

  • The private sector must be the primary source of mortgage credit and bear the primary burden for credit losses.
  • There must be an explicit federal backstop after private capital.
  • Credit must remain available in times of market stress.
  • Private firms benefiting from access to a government backstop must be subject to strong oversight. (4-5)

We are still far from having a legislative fix to the housing finance system, but it is helpful to have reports like this to focus us on where there is broad agreement so that legislators can tackle the areas where the differences remain.

Foreclosure Alternatives


Realtor.com quoted me in 3 Foreclosure Alternatives: What to Do Before Your Mortgage Goes Underwater. It opens,

Maybe you’ve missed a couple of monthly mortgage payments. Maybe a notice of default from your lender is looming right now. You understand the severity of the situation, but what most homeowners don’t know is that foreclosure is not the only option you have when you’re no longer able to afford your house.

The first step for anyone in risk of foreclosure is to get in contact with your lender. This shows that you are aware of the problem and committed to finding a solution—and trust us, that will go a long way. The earlier you reach out, the greater shot you have of amicably rectifying the problem.

After you speak with your lender, your lender will lay out your options, including the foreclosure alternatives that you might be able to take advantage of. Let’s take a closer look at some of the alternatives so you—and your credit history—don’t suffer the ultimate blow.

1. Standard sale or rental

If your home is currently valued at more than you owe and if you are up to date on your mortgage payments (but you anticipate that paying your mortgage could become a problem), you can hold out as long as possible for a buyer.

You can also try to rent out the home to cover the mortgage payments until the house sells, says Carolyn Rae Cole, a Realtor® with Nourmand & Associates. In the end, virtually all homes eventually sell—it’s just about pricing.

2. Short sale

When a home has fallen in value and is priced so low that there isn’t enough equity to cover the mortgage, you might have the option to conduct a short sale. It’s also known as going “underwater.” This means the lender agrees to accept less than the amount the borrower owes through a sale of the property to a third party.

A short sale works like this: A specialist brokers a deal with the mortgage lender to sell the home for whatever the market will bear. If the amount of the sale is for less than what’s owed on the mortgage, the lender gets the money from the sale and relinquishes the remaining debt. (This means you won’t owe anything else.) In a short sale, the lender usually pays for the seller’s closing costs. A traditional sale takes about 30 to 45 days to close after the offer is accepted, whereas a short sale can take 90 to 120 days, sometimes even longer.

Sellers will need to prove hardship—like a loss of primary income or death of a spouse—to their lender. In addition to explaining why they’re unable to make mortgage payments, sellers will have to provide supporting financial documents to the lender to consider for a short sale.

3. Deed in lieu of foreclosure agreement

A deed in lieu of foreclosure is a transaction between a lender and borrower that effectively ends a home loan. Essentially both parties agree to avoid a lengthy foreclosure proceeding by the borrower voluntarily turning over the home’s deed to a lender, says professor David Reiss of Brooklyn Law School
. The lender then releases the borrower from any further liability relating to the mortgage. However, if the property is worth significantly less than the outstanding mortgage, the lender may require the borrower to pay a portion of the remaining loan balance.

You might be eligible for a deed in lieu if you’re experiencing financial hardship, can’t afford your current mortgage payment, and were unable to sell your property at fair market value for at least 90 days.

Bottom line: This agreement is a negotiated solution to a bad situation—borrowers who have fallen behind on their payments are going to lose their house and the lender is not getting paid back in full.

Selling Yourself When You Have A Broker

image by Russellprisco

Realtor.com quoted me in Selling Your House Privately If You Have a Listing Agent: OK or a Big N-O? It opens,

So your home is for sale, and you’ve signed a contract with a real estate agent, but you were actually able to nab a buyer through your own efforts. Maybe it was through word of mouth or your aggressive push on Facebook (you should really apologize to your friends for posting so many pictures of your house!), but someone is writing you an offer and really wants to buy your house. Having found a buyer on your own, are you still legally obligated to pay real estate fees or commission? Here’s how to know if you’re on the hook.

Read your listing agreement

In most states, a seller and an agent draw up something called a listing agreement. The listing agreement details the rights and responsibilities of the seller and the broker, and usually outlines the circumstances when a broker is due a commission.

“If it is an open listing or an exclusive agency listing, the seller can sell the property and not have to pay the broker a commission,” says David Reiss, professor of law at Brooklyn Law School
.

Things get tricky if the listing agreement confers an exclusive right to sell. This means the real estate agent has the sole right to sell the property. All offers must go through him or her, and for any sale, you’re obligated to pay the agent the commission spelled out in the contract, according to Marc D. Markel, a board-certified Texas attorney in residential and commercial real estate law. Agents rely on these exclusive listing agreements to avoid putting in what can be months of free work without seeing a payoff. For this reason, the agreement outlines the many ways an agent earns a commission, including what happens if the seller breaches the exclusive agreement.

The loopholes

If the sellers do find a buyer on their own, despite having a contract with an agent, they may be able to negotiate a reduced commission with the agent. But the sellers should be up-front about their potential to find their own buyer when drawing up the exclusive-right-to-sell listing agreement, says Markel. Maybe they know of a friend of a friend who is looking for a house, or they plan on marketing their home on social media.

If the sellers feel as if they are doing all the work, they might also be able to modify the existing agreement and add a termination if the broker doesn’t meet certain obligations, like selling the home within a certain time frame, says Sandy Straley, a real estate agent in Layton, UT. Other obligations for the listing could include organizing open houses, creating and distributing printed materials, and even the posting of videos shot by drones, says Markel.

Buying a Foreclosure or Short Sale

DailyWorth quoted me in Should I Buy a Foreclosure or Short Sale? It reads, in part,

I’m looking to buy a new home, and I’ve noticed that there are a couple of “short sale” and foreclosed homes in the area where I’m interested in living. These homes are priced substantially lower than others, and I’m wondering what the catch is. I’ve heard that short sales or foreclosures often need repairs. What else do I need to know to decide whether to invest in one of these properties?

Purchasing a home through a short sale or a foreclosure process can be a way to get a good deal on a property. But it isn’t for the faint of heart. Both processes are likely to be more complicated than purchasing a home on the open market.

First, make sure you understand the differences between these categories. Both are used when a property owner is in financial distress and can no longer afford mortgage payments.

In a short sale, the proceeds from the sale will fall short of the debt owed on the property. Such a sale can only occur if the mortgage holder (usually a bank) has agreed to accept less than the amount owed on the loan.

In a foreclosure, on the other hand, the mortgage holder has repossessed the property and is trying to recoup its losses by selling the house for the amount still owed on the loan. That amount is typically still less than the market value of the home.

Here are some of the common issues you may encounter when buying a foreclosure or short sale.

Purchasing Delays
If you’re considering buying a property listed as short sale or foreclosure, keep in mind a few things, experts say.“The process for purchasing this kind of property may not be as easy as purchasing a home directly from a seller who is current on their mortgage,” says Colin McDonald, real estate agent with Berkshire Hathaway HomeServices Blake in Delmar, N.Y.For instance, it typically takes six to eight weeks to close on a normal home, McDonald says. But with a short sale or foreclosure, the property may not close for six months or even a year.“[W]hen a property is being listed as a short sale or foreclosure, you’re no longer just dealing with the seller,” McDonald says. “A bank is now involved, and unfortunately, they only care about getting what is owed to them. They will drag the process on for as long as they like.”

Short sales can also take months to get lender approval. “The seller’s bank can make things very difficult, making the borrower jump through many hoops — hoops that can take a long time to navigate,” warns David Reiss, a professor of law at Brooklyn Law School who writes and teaches about real estate.

And in the end, the bank may respond with a counteroffer that doesn’t meet your budget or terms. “So you might wait for a long time only to be disappointed,” says Sep Niakan, owner of Condo Black Book, a leading condo search website in Miami and broker of HB Roswell Realty.

*     *     *
 Potential Additional Fees
While the price of the home may be low, a foreclosure or short sale often comes with additional transaction costs. With a foreclosure, you may have to pay transfer taxes as well as any superior liens on the property. You may also have to pay an additional fee to the foreclosure company.
Typically, in a short sale, there is a negotiator involved who will require a fee, such as 2.5 percent of the purchase price, McDonald says. The buyer is usually required to pay this fee.You also may have to pay back taxes or other past dues associated with the property. If you buy a condo-foreclosure, for instance, “there may be many years of past due condo association fees that may not appear anywhere in public record, and you might end up inheriting a very large debt,” Niakan says. “Some local and state laws limit the amount you would be responsible for in those cases, but do your homework.”Purchasing a home at a price that is significantly below market always sounds like a good thing — and it can be for the right person. But keep in mind that if the property is really great, “there will be others who will also be interested in it,” McDonald warns. “This includes veteran investors who have deep pockets of cash.”If you hope to get a great home for a low price through a foreclosure or short sale, be sure to do your homework and be aware that it may take a long time and come with extra costs and repairs. And at the end of the day, buying a short sale or foreclosure isn’t for everyone.

“While you may get a good price, you will be paying for the house with uncertainty, delay, and frustration,” Reiss says. “You’ll need to determine for yourself whether it is worth it.”

Blockchain and Real Estate

CoinDesk.com quoted me in Land Registry: A Big Blockchain Use Case Explored. It opens,

With distributed ledger technology being promoted as a benefit to everything from farming to Fair Trade coffee, use case investigation has emerged as a full-time fascination for many.

In this light, one popular blockchain use case that has remained generally outside scrutiny has been land title projects started in countries including in Georgia, Sweden and the Ukraine.

One could argue land registries seemed to become newsworthy only after work on the use case had begun. However, those working on projects disagree, asserting that land registries could prove one of the first viable beachheads for blockchain.

Elliot Hedman, chief operating officer of Bitland Global, the technology partner for a real estate title registration program in Ghana, for example, said that issues with land rights make it a logical fit.

Hedman told CoinDesk: “As for the benefit of a blockchain-based land registry, look to Haiti. There are still people fighting over whose land is whose. When disaster struck, all of their records were on paper, that being if they were written down at all.”

Hedman argued that, with a blockchain-based registry employing a network of distributed databases as a way to facilitate data exchange, the “monumental headache” associated with a recovery effort would cease.

Modern real estate

To understand the potential of a blockchain land registry system, analysts argue one must first understand how property changes hands.

When a purchaser seeks to buy property today, he or she must find and secure the title and have the lawful owner sign it over.

This seems simple on the surface, but the devil is in the details. For a large number of residential mortgage holders, flawed paperwork, forged signatures and defects in foreclosure and mortgage documents have marred proper documentation of property ownership.

The problem is so acute that Bank of America attempted foreclosure on properties for which it did not have mortgages in the wake of the financial crisis.

Readers may also recall the proliferation of NINJA (No Income, No Job or Assets) subprime loans during the Great Recession and how this practice created a flood of distressed assets that banks were simply unable to handle.

The resulting situation means that the property no longer has a ‘good title’ attached to it and is no longer legally sellable, leaving the prospective buyer in many cases with no remedies.

Economic booster

Land registry blockchains seek to fix these problems.

By using hashes to identify every real estate transaction (thus making it publicly available and searchable), proponents argue issues such as who is the legal owner of a property can be remedied.

“Land registry records are pretty reliable methods for maintaining land records, but they are expensive and inefficient,” David Reiss, professor of law and academic program director at the Center for Urban Business Entrepreneurship, told CoinDesk.

He explained:  “There is good reason to think that blockchain technology could serve as the basis for a more reliable, cheaper and more efficient land registry.”

When Buyers Change Their Minds

The Wall Street Journal quoted me in When Home Buyers Change Their Minds (behind paywall). It opens,

The offer was accepted. The mortgage was approved. What happens when the buyer gets cold feet and wants to back out of the deal?

Jason Michael faced this issue about 18 months ago when he listed his three-bedroom home in St. Louis. Mr. Michael, a 36-year-old public-relations executive, asked $130,000 for his home and accepted an offer for $127,000. The buyers posted a $1,000 deposit of “earnest money,” completed inspections, negotiated repairs and were approved for a mortgage.

Then they told Mr. Michael that they had found another house and didn’t want to move ahead with the purchase.

While the contract allowed Mr. Michael to pocket the deposit if the buyers defaulted, they refused to authorize their agent to release it. Only after Mr. Michael threatened to sue did they surrender the $1,000.

“My agent had said that people don’t back out of house purchases—that this won’t happen,” Mr. Michael says. “But now I approach it as if the buyer can back out until the very last minute.” He ultimately decided to rent out the house.

According to an online survey of 2,241 adults conducted for finance website Nerdwallet.com in January, home-buyer’s remorse isn’t uncommon. Nearly half (49%) of homeowners who responded said they would do something differently if they had to go through the process again. Broken down by age group, 61% of Generation Xers (the mid-1960s through the 1970s) and 57% of millennial homeowners (born in the early 1980s through about 2004) indicated they had regrets. Many wished they had bought a bigger home or saved more money before buying.

*     *      *

Here are a few things to consider if you might want to back out of your real-estate contract. Buyers and sellers should consult a qualified real-estate attorney for advice.

• Craft carefully. Rather than having a mortgage contingency allowing you to obtain a mortgage “at prevailing rates,” specify that the mortgage rate can be no more than 4%, for example. Or, consider making the contract contingent on the mortgage actually being funded by the lender. “This extends the contingency all the way to the closing,” says David Reiss, a Brooklyn Law School professor who specializes in real estate.

• Sharpen your negotiation skills. Even if you can’t back out legally, try to negotiate a reduction or return of the deposit with the seller. In a market where prices are rising and the homeowner can get a higher price for their home, there might be a chance to come to terms.

• Remember the broker. Even if the seller lets the buyer off the hook, he may still be liable to the broker for the commission. Contracts state that the commission is due when the broker finds a ready, willing and able buyer. Many brokers will work with the seller in this situation, Mr. Haber says, but it is an issue that needs to be addressed.