Here is a graphic from Ali Wolf, the chief economist at Zonda. The textbook way to clear a market is to change the price. So, there are two questions here. (1) Why not change the price. And (2) If not, why is the most popular alternative mortgage buydowns.
I remember taking the re-fi train on a little downward journey between 2010 and 2012ish. I recall that in 2010 we were happy to get 5.5% on a 30yr fixed. A year later we were happy to drop a 100 basis points and get a drop in the monthly payments going forward. We were happy a year later when there was another 100 bp drop. We did the math long term and it made sense both times, and the local bank seemed happy with to slurp up the transaction costs each time--they were just selling the note back to BB&T after each closing.
The 30 year mortgage is a convenient fiction--no one ever pays them to full term at the starting rate--but everyone understands it as a tool for assessing payment capacity of a homebuyer. The buydown makes sense as a sales tool and if it wasn't sustainable in the short term for the builders they wouldn't be using it. Because of the training I've received from this source and others I don't think Fed actions are going to have much impact on lending rates over the next 18 months. However, I think that high rates--even with buydowns--will eventually start a downward trend. Of course, I'm just blowing smoke because I've grown up in a low rate world.
If we consider prepayment opportunity as having inherent option value to the homebuyer, it means that current monthly payments at the buy down rate are more (optionality included) expensive then exactly equal monthly payments using a market consistent mortgage rate.
Throughout the great moderation, homeowners saw continuous gains from being able to refinance at ever lower rates. If current homebuyers start out at below market rates they will not have the same opportunities.
The reason to use rate buydowns rather than price reductions is not as complex as you make it out. The rate buydown does more to lower the monthly payment on a 30-year amortizing mortgage. With amortization, repayment of principal is backloaded, and payment of interest is front-loaded. In an inflationary environment, lowering the interest rate does more to reduce the upfront burden. A lot of homebuyers are payment-constrained, so this enables them to buy the house.
Why are homebuilder rate buydowns effective?
I remember taking the re-fi train on a little downward journey between 2010 and 2012ish. I recall that in 2010 we were happy to get 5.5% on a 30yr fixed. A year later we were happy to drop a 100 basis points and get a drop in the monthly payments going forward. We were happy a year later when there was another 100 bp drop. We did the math long term and it made sense both times, and the local bank seemed happy with to slurp up the transaction costs each time--they were just selling the note back to BB&T after each closing.
The 30 year mortgage is a convenient fiction--no one ever pays them to full term at the starting rate--but everyone understands it as a tool for assessing payment capacity of a homebuyer. The buydown makes sense as a sales tool and if it wasn't sustainable in the short term for the builders they wouldn't be using it. Because of the training I've received from this source and others I don't think Fed actions are going to have much impact on lending rates over the next 18 months. However, I think that high rates--even with buydowns--will eventually start a downward trend. Of course, I'm just blowing smoke because I've grown up in a low rate world.
If we consider prepayment opportunity as having inherent option value to the homebuyer, it means that current monthly payments at the buy down rate are more (optionality included) expensive then exactly equal monthly payments using a market consistent mortgage rate.
Throughout the great moderation, homeowners saw continuous gains from being able to refinance at ever lower rates. If current homebuyers start out at below market rates they will not have the same opportunities.
The reason to use rate buydowns rather than price reductions is not as complex as you make it out. The rate buydown does more to lower the monthly payment on a 30-year amortizing mortgage. With amortization, repayment of principal is backloaded, and payment of interest is front-loaded. In an inflationary environment, lowering the interest rate does more to reduce the upfront burden. A lot of homebuyers are payment-constrained, so this enables them to buy the house.