Author: Vera Chang
Date: 11/13/2022
2022 is another unprecedented year. With mortgage rates soaring straight from 3ish at the beginning of the year to 7ish (owner-occupied, 30 Year fixed), few of us have ever experienced such an era that every morning we would find ourselves lost thousands of dollars from increased interest rate. It is a great challenge on the affordability for every buyer, especially for those who are still waiting for the new houses to be completed. They feel hopeless and abandoned by our policy maker, because after all, Powell (Fed Reserve Chairman) initially claimed that inflation would only be transitory, and everything would be back to normal in a short term.
However, it’s been proved that the Fed's judgment was only off track by “a little”. Inflation rate has broke a record after another. Market has been forced to cool down by Fed’s record-keeping rate hike path and Quantitative Tapering policy with a fear of our economy going into stagnation like 70s.
No sign of deceleration of monetary tightening, therefore one of the key words for 2023 that taps our nerves is: recession. At the beginning of the year, we will be standing at the highest interest rates for the past decade, witnessing the sticky high inflation, layoff waves, and many unpredictable. The news from every city is telling the same story, house prices are crashing, transaction volumes are avalanche, and it seems that 2008 will be staged again.
Is this really the case?
Looking back at 2008, it was a financial crisis caused by a credit crisis in the housing market. In short, banks maximized the capacity that people could theoretically afford. In many cases, buyers didn’t even need to contribute with their own funds (down payment) in a purchase transaction. Once the economy turned around and the household income declined, homeowners just walked away without bearing any losses. In other words, 2008 was a tsunami triggered by the defect design of subprime lending business, and it was also the most profound lesson we learnt in the financial crisis.
Let’s turn our focus back on 2022, in addition to the down payment of 3% for first-time buyers, all other buyers are required to put at least a 5% down, and if the down payment is less than 20%, they need to purchase mortgage insurance. With this policy in place and thanks to the booming year of 2020 and 2021, as of the second quarter of 2022, the average home equity ratio in the United States reached 70.5%, the highest level since 1983. Before homeowners want to default on their mortgage, housing prices need to fall sharply by at least 30%.
Foreclosure wave is hard to repeat in foreseeable future. And what we heard the most is:
1) For new houses, developers are having an extensive promotion for properties on some less ideal location through the end of 2022 to claw back funds, but this is only a short-term behavior.
2) Existing housing market, the sellers sit on the lowest interest rate in history, if the offer price is not particularly satisfied, they are not willing to sell, so a great deal of transactions are a tug of war.
What can new home buyers and investors do in this less than active market?
1. Keep positive
Even if the general market is not particularly favorable, there will be a very small number of good deals, such as the last or two properties on builder’s list. I have seen builders cut prices by more than 10%.
Or some sellers need to relocate and sell their homes since they do not want to manage properties remotely.
Or some elderly need to move to nursing home due to physical conditions and need to sell their real estate that has been lived in for many years.
Regardless of which scenario above, it is a very rare opportunity for buyers, after all, we haven’t seen such occasions that buyer can negotiate with sellers and talk about contingency for a long time. To refresh your memory, the heat of the US housing market started much earlier than pandemic. Author herself had already begun to experience the bidding war in 2017. Comparing to those times, market today can be viewed to be very buyer friendly.
2. Choose the loan program that suits you
What we are talking about is not the choice between Fixed and Adjustable Rate, but a very special loan program: temporary buydown. Simply put, use the seller's or realtor's credit to reduce the monthly payment for the first 1-3 years.
It is different from the well-known permanent buydown, where buyer pays some extra cost called point fee, to lower the mortgage rate for the life of the term (let's say 30 years of loans). The problem of this approach is, if you refinance your mortgage not long after the closing, the unused point fee paid at closing will be forfeited, while using temporary buydown, you can claw back any remaining unused credit and put back in your pocket.
So, in the current market, temporary buydown is more suitable.
Let’s take a closer look on how it works
The buyer receives a credit from the seller or/and realtor at closing and deposit it to your future escrow account. The total amount will be amortized gradually to offset some of the monthly payment for the next 1-3 years (there are 3-2-1, 2-1, 1-0 three different choices that buyers can choose from).
Assuming that the buyer chooses a three-year 3-2-1 project, the buyer's current interest rate is 7%, which is equivalent to the buyer only having to pay (7%-3%) = 4% interest rate in the first year, and the second year (7%-2%) = 5% The interest rate for the third year (7%-1%) = 6% of the interest rate. The difference between the annual interest rate paid and the theoretically calculated monthly payment at 7% is made up by the seller or/and Realtor's credit.
Below is a sample of a 2-year, 2-1 program:
You may argue, I can also directly use the seller or/and realtor credit to offset my closing cost, isn't it the same? The answer is no.
Let's talk about the benefits of temporary buydown
(1) Buyer can receive more credits than before
For each transaction, the total amount of credit (Interested Party Contribution) that buyers can accept from seller or realtor is limited to lesser of Interested Party Contribution and closing cost. But this program can largely increase the total credit buyer can receive, since it's not considered as Interested Party Contribution.
(2) Unused credit can be clawed back
Assuming a client does a refinance in any year during the buy down period, the rest of the credit can be refunded to the buyer. Isn't it much more cost-effective than permanent buydown?
(3) Alleviate short-term cash flow pressure
For most buyer’s market, many people will ask the seller to reduce price directly, the benefits of doing so for buyers are less than ideal from cash flow’s perspective: for example, if the price is reduced by 20,000, buyer will save 20% of $20,000 = $4,000 (here it is assumed that the buyer has a down payment of 20% ) at closing, and the remaining reduced $16,000 loan will only save the monthly payments of $106 (based on 7% interest rate, 30-year loan). Therefore, if the short-term cash flow is under pressure, you can consider using temporary buydown which allow you to save a lot more in the first a few years.
At the end
Each of 2020, 2021, 2022 is an extraordinary year for us. 2023 will be a critical and turning year, if the Fed wins, we will continue to suffer from high interest rates; If the Fed loses the bet and the economy makes a hard landing, interest rates will fall, but we will still be hurt in other ways.
However, author firmly believes that no matter in any market, as long as you can seize the opportunity and find the right direction, you will not become the grain of sand that is washed away by the big waves.
If you have any loan questions, please feel free to contact Vera:
Cell: 347-688-9191
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