Dirt-cheap loans on new homes

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Would you buy a brand-new home if you could lock in an interest rate of, say, 3.63 percent on a 30-year mortgage? Homebuilders who’ve offered to “buy down” buyers’ interest rates hope your answer will be yes.

Interest-rate buy-downs aren’t new. In fact, builders, private home sellers and buyers have long been able to pay an extra fee to buy down the interest rate on a home loan.

The extra fee, payable upfront, is priced in “points,” and each point is equal to 1 percent of the loan amount. For each point (or partial point) that’s paid, the interest rate on the loan is reduced by a set amount that’s determined by the lender. Homebuilders that offer the incentive pay the extra points on the borrower’s behalf as an inducement for him or her to buy a home.

Some buy-downs are temporary, which means the interest rate is reduced only for one, two or three years, after which the rate rises to a fixed figure for the remainder of the term. But most builders today offer a buy-down that’s good for the full 30-year term of the loan.

Dan Klinger, president of K. Hovnanian American Mortgage in Boynton Beach, Fla., describes the buy-down as “the incentive that keeps on giving.”

“Over a 30-year period, it’s a tremendous amount of savings,” he says.

Gopal Ahluwalia, vice president of research at the National Association of Home Builders, or NAHB, in Washington, D.C., also says that the savings can be significant. For example, a buy-down from 5.5 percent to 4.5 percent on a $200,000 loan amount would lower the borrower’s principal and interest payment from $1,135 to $1,013, a monthly savings of $122.

A buy-down may help some new-home buyers qualify for a loan because the lower monthly payment improves the borrower’s debt-to-income ratio, Klinger says.

The caveat is that not all buyers can qualify for a buy-down. The guidelines vary from one builder to the next, but a strong credit score and a comfortable down payment often are required.

“When you read the fine print on these interest rates, (it says that) you need to be a very well-qualified homebuyer,” says John Burns, president of John Burns Real Estate Consulting in Irvine, Calif.

Buy-downs lure new-home buyers

Buy-downs, upgrades and other incentives are especially important today because the new-home market has been in a slump. Sales of new-built, single-family homes increased 4.7 percent, to a seasonally adjusted annualized pace of 337,000 units in February 2009, compared with 322,000 units in January, according to the U.S. Department of Commerce. Those figures were dwarfed by the February 2008 pace of 572,000 units and the 2005 annual total of 1.2 million new homes sold.

An excess supply of for-sale new homes has been a problem for builders as well. In 2005, the supply was only 4.8 months at the pace of sales in that year. The supply rose to 9.7 months in February 2008 and then increased to slightly more than 12 months in early 2009. That means it would take a year for builders to sell all homes they’ve already constructed at the current pace of sales. Buyers can expect that builders will continue to offer inducements until that standing inventory is reduced.

Buyers who want to take advantage of a builder-paid buy-down should visit several new-home developments and find out what deals are offered. That’s because not all builders offer this incentive, says Stephen Melman, NAHB director of economic services.  In fact, a NAHB survey found that 29 percent of builders offered a buy-down in February 2009. A year earlier, only 16 percent said they offered this incentive. That percentage has fluctuated, yet the trend line has been upward as the housing slump has lengthened.

More than half of the builders said buy-downs were at least somewhat effective in stimulating sales, but 35 percent said they weren’t at all effective. Klinger says an interest-rate buy-down offered by homebuilder Hovnanian Corp. was “not a silver bullet,” but was helpful enough to entice some people off the proverbial fence of indecision into homeownership. Other builders that have offered a buy-down include Toll Bros. and Lennar Corp., neither of which would discuss this program.

Buy-down offers may be limited in scope

Burns suggests that buy-downs are an effective inducement because many buyers tend to focus on affordability and their monthly payment, sometimes even more than they focus on the price of the house.

“Getting the payment down at or below somebody’s rent is a very compelling story,” he says.

Naturally, there are trade-offs and restrictions. Buy-downs tend to be offered only in certain states or specific developments or on the purchase of certain models of new homes, rather than across the builder’s entire inventory.

The incentives may be more prevalent in such states as Arizona, California, Florida, Nevada and Texas, where volume-oriented homebuilders have a sizable presence, Burns says. Buy-downs also are more likely to be offered on completed homes because builders have more flexibility to negotiate on those properties.

Larger homebuilders may be more likely than their smaller competitors to offer a buy-down because most of the biggest builders own an in-house mortgage company, and that may reduce their cost of the buy-down. Buyers typically are required to obtain a loan through the builder’s mortgage company to take advantage of this type of offer. Buyers should remember that even if the builder offers a buy-down through a captive mortgage company, they still could find a lower interest rate or cheaper financing costs elsewhere.

Buy-down may be part of package

Most builders offer a variety of incentives and then limit the total package to a specific undisclosed sum that is often about 3 percent to 4 percent of the sales price of the house, says Melman. For example, if the builder has a figure of $10,500 in mind and the buy-down costs $9,500 in points, only $1,000 will be on offer for other incentives. That means the upgrades the buyer also wants would be included only at an additional cost, instead of as freebies. As Klinger says, “There is only so much room (to negotiate) in every deal.”

If the builder is keen to make the sale and the allowance is generous, the builder might include some upgrades and even pay some or all of the borrower’s closing costs as well as the points to buy down the interest rate.

“The idea is to minimize the out-of-pocket expense for the buyer because no-money-down is gone,” Klinger says.

Buyers should focus on the value of the whole package. On that basis, a 30-year interest rate reduction may be much more compelling than fancier flooring or better kitchen appliances.