How Temporary Interest Rate Reductions Work for Home Buyers and Sellers

Homebuyers are looking for ways to lower mortgage rates. As a result, the once-popular home-selling strategy is making a comeback. This is called a temporary reduction and was widely used when mortgage rates rose in the late 1970s and early 1980s.

With mortgage rates at their highest in 20 years, the Fed is expected to mortgage rate Twice this year. Fewer people are buying homes as rising interest rates make it unaffordable for buyers. In some markets, negotiating power even shifts from seller to buyer.

In this situation — when interest rates are rising and home sellers have to struggle to attract buyers — temporary buyouts can flourish. Time to dust them off and put them to work.

Temporary buyouts reduce a homebuyer’s monthly payments for the first year, or sometimes the first two or three years. Instead of paying the full monthly mortgage payment from the start, home buyers will pay at a discount for a year or more.

This is achieved by subsidizing the interest rates paid by borrowers. For example, let’s say a buyer takes out a mortgage at 7% and buys for a year. Due to the reduction, monthly payments are based on a 6% interest rate for the first year, rising to 7% thereafter.

If in this hypothetical example the borrower takes out a $300,000 mortgage, the buyer’s principal and interest payments will be $1,799 per month in the first year, then rise to $1,996 per month in years 2-30 Dollar. A buyout under these terms will save the borrower about $197 in monthly interest for the first year, for a total of $2,367.

Traditionally, most temporary buyouts have been paid by home builders and home sellers as closing costs equal to the interest saved by the buyer. In the example above, the buyer saves $2,367 and the seller deposits this amount into an escrow account upon closing. The loan servicer withdraws from the account each month the difference between the full loan and the discounted bill paid by the homeowner.

The twist these days is that when there are fewer mortgages to write, some lenders offer temporary buyouts as a means to compete for business. This is a feature worth watching when comparing lenders.

“When I entered real estate in 1978, buyouts were routine,” said Lou Barnes, senior loan officer at Cherry Creek Mortgage in Boulder, Colorado. Mortgage rates were rising as fast then as they are now, Barnes said, and the purpose of buying a home was to ease the transition for buyers from lower interest rates or lower rents.

Temporary home buying is now attracting first-time buyers, alarmed by how quickly mortgage rates are rising, draining their savings on down payments and transaction costs. Temporary payment reductions allow borrowers to top up savings or put money toward home upgrades.

Bill Banfield, executive vice president of capital markets at Rocket Mortgage, said: “You know what it’s like to buy a home: You might want to buy new carpet, new appliances — what it takes to make it your home.”

Banfield said Rocket is paying to reduce its holdings for a year through the end of 2022, which the company calls Inflation Buster. New American Funding also offers lender-paid reductions, Ben Lane, editorial managing director of New American Funding, said via email. Other lenders have recently started marketing buyouts paid by sellers.

Buyouts can last more than a year, allowing borrowers to expand their savings:

• A 2-1 buyout would reduce the rate by two percentage points in the first year, then by a percentage point in the second year, before raising it to full rate.

• 3-2-1 cut interest rates for three years, 3 percentage points in the first year, 2 percentage points in the second year, and 1 percentage point in the third year.

• With a 1-1-1 buyout, interest rates are reduced by 1 percentage point over three years.

Temporary markdowns are “older than flares,” Banfield said, and there are signs they’re making a comeback as the magic of negotiation shifts from sellers to buyers. Why: Buyouts are a time-tested way to attract reluctant buyers.

A seller may offer a markdown instead of a markdown. That way, sellers can brag about getting the price they want, while buyers save money.

For example, suppose a buyer and seller are $7,000 apart after a few days of haggling. A temporary buyout resolves the impasse:

• The buyer pays the price both parties are trapped in: $7,000 more than the buyer is willing to pay.

• As a compromise, the seller purchases the buyer’s $300,000 mortgage on a 2-1 basis at 7%. The 2-1 buyout saved the buyer $6,992 over the first two years of the loan. The $6,992 came from the seller’s gain at the close — the equivalent of a price cut, but the neighbors couldn’t see it.

Either party can suggest a buy. Sellers can offer one, as a competitive strategy. The buyer can ask for a concession as the seller.

Lenders must qualify borrowers at the full interest rate, which requires lenders to determine the borrower’s ability to repay the loan after the rate cut.

Fannie Mae and Freddie Mac, the government-funded mortgage companies, imposed restrictions on seller concessions, including temporary price cuts. Limits vary by down payment amount.

Fannie and Freddie also limited temporary buyouts to a maximum of three years. To cushion the payment shock, real interest rates can only rise by one percentage point per year. So the effective interest rate for borrowers cannot jump from 5% to 7%; it must rise from 5% to 6% for a year before it stabilizes at 7%.

A temporary buyout is similar to Adjustable Rate Mortgage Because borrowers start out paying at one rate and later at another. But the buyout is not ARM.

A key difference is what happens to interest rates. On an ARM, interest rates and monthly repayments can change periodically over the life of the loan. With buying, interest rates never change. Instead, the seller (or sometimes the lender) pays a portion of the borrower’s interest in the first or second or third year, but the underlying note rate remains the same.

one Arguments in favor of ARM They last longer and save more money, at least for the first five years, said Carolyn Morganbesser, assistant vice president of mortgage origination at Affinity Federal Credit Union in New Jersey.

“ARM is going to let you into your home; it’s going to give you the lowest possible payout at this particular time,” Morganbesser said.

While this may be true, one downside to ARM is that sellers can’t offer them as a concession. In her area, Morganbesser said, that objection is now irrelevant because it’s still a strong seller’s market, so sellers offer little incentive to back down.

But off the East Coast, sellers are already vying for fewer and fewer willing buyers. In these markets where buyers have a choice, sellers may be inclined to offer reduced prices.

Payment discount point is a way to permanently lower the interest rate, so make monthly repayments. Sellers can pay discount points as sales incentives. But there are discount points:

• Monthly savings are less. Paying a discount point (equivalent to 1% of the loan amount) usually reduces the interest rate by about a quarter of a percentage point.

• While the monthly savings are nothing to brag about, the cumulative savings can be substantial over a few years.

• Cumulative savings typically require six to seven years of recurring payments to exceed up-front costs.

“If you sold or refinanced before that six years, you’d be leaving money on the table,” Barnes wrote in an email.

By contrast, the buyer’s savings from a temporary buyout equals the seller’s upfront cost over one to three years.

The imminent resurgence of temporary home buying is a harbinger of a more traditional housing market in which sellers and their realtors no longer pick a dozen desperate offers for each house.