Tricks of the Trade

Continuing with last week's discussion on homeownership, new home builders are zeroing in on what matters most to buyers: mortgage rates. While the price of a home plays a role in purchasing decisions, the key factor is the monthly payment.

If the buyer can afford the payment, the home's price becomes a secondary metric. This is the strategy builders are leveraging today—buying down the interest rate to reduce monthly payments for new buyers. However, what many buyers overlook is the impact this has on the actual price of the home.

This strategy is incredibly valuable—if you're builder.  

In this example, comparing a loan with interest rates of 6.5% and 4.0%, a rate buydown could save a homebuyer $47,000 in interest over the life of a 30-year loan. However, these savings are only fully realized after the full 30 years. With the same monthly payment but at a 4.0% interest rate, the buyer could afford an additional $160,000 of the loan amount. Because of the rate buydown, the increased cost of the home is paid up front when purchasing the home.

Home buyers get caught when they have to sell their home sooner than the appreciation in value can offset the excess purchase price. Depending on the market appreciation, that could be one year or 10 years. Maybe more in dire circumstances. It’s no surprise this has left many homebuyers underwater, with a particularly noticeable increase among those who financed through a homebuilder.

Percentage of Loans Currently Underwater

• Lennar (builder-issued loans): 27%
• DR Horton Loans: 18%
• FHA Loans via Quicken (not builder-owned): 10%

Builder financing is consistently producing more underwater homeowners. That’s not a coincidence.

There’s some FOMO among first-time homebuyers that they’ve missed out on the significant 56% increase in home value appreciation over the past five years. Real appreciation over time can offset the impact of overpaying, but should we expect similar growth moving forward? My gut says absolutely not—unless interest rates return to pre-pandemic levels. The pandemic created a unique situation: historically low interest rates, a strong desire to relocate, and government stimulus. 

 Be cautious when you hear the phrase that often precedes disaster:
“It’s different this time.” 

Just remember:
No, it’s not.