Jack Church and his wife Nicole were keeping their options open when they decided to relocate from Phoenix to northern Alabama.
The area’s strong economy and low cost of living attracted them, and Church, a radio host who grew up in Tennessee, was keen to return to the Southeast, where his show gets most of its distribution.
Touring homes outside of Huntsville, Ala., the couple found that new construction was the cheaper option, thanks in part to mortgage rate incentives offered by builder D.R. Horton. In September, they closed on a three-bedroom, two-bathroom home for about $280,000. At a time when average mortgage rates were around 6%, they locked in a sub-5% interest rate for the life of their loan, and even lower rates in their first two years.
“We got a really good deal,” Church said.
House hunters are likely to continue to see offers like this, known as mortgage rate buydowns, in the coming year. Homebuilders have long talked about easing up on the mortgage rate promotions they’ve relied on to help woo cost-conscious buyers in recent years, but rising competition from the existing home market may make that challenging.
Builders began offering the incentives in 2022 and 2023 as many potential buyers found themselves priced out of the market due to stubbornly high mortgage rates. All the while, existing home inventory has been weak as homeowners with ultra-low mortgage rates have stayed put, pushing more homebuyers to look at new construction.
Next year, market experts expect more old homes to hit the market, giving builders fresh competition and buyers more leverage.
Different incentives
Builders offer a few different types of below-market-rate mortgages, usually on the condition that a buyer uses an in-house financing arm or preferred lender. They typically fund the rate incentives by purchasing blocks of loans in advance at discounted rates.
In a permanent buydown, a homebuyer’s mortgage is set at a below-market rate for all 30 years of the loan. Other rate buydowns can be structured as what’s known as 3-2-1 or 2-1 deals, which offer the lowest rates for the first two to three years of the mortgage, and a higher rate afterward.
Rate buydowns aren’t the only incentives builders offer, but they’re among the most popular. Other common carrots for customers — especially those paying cash — include closing cost assistance, deluxe appliances or upgraded fixtures.
“When we promote a rate, that gets them through the door,” said Nanette Pfister, vice president of sales at homebuilder Epcon Communities, which began offering rate buydowns in some of its locations last year.
Epcon specializes in step-free homes for older clientele, many of whom have the flexibility to finance or pay cash. Just over half of the company’s customers this year were cash buyers, while around 39% used conventional mortgages that can be buydown eligible. Cash buyers can be eligible for other incentives, like credits toward home design upgrades.
Even though mortgage rates haven’t dropped below 6% this year, nearly half of recent homebuyers have managed to snag an interest rate below 5%, real estate marketplace Zillow found in October. More than a third of those buyers did so by getting special financing from a builder or seller.
Jacksonville, Fla.-based real estate agent Shawana Boyer said she often shows her clients a mix of new construction and existing homes. These days, many end up opting for new construction for the interest rate savings, she said.
“You can’t beat it,” Boyer said.
A hit to builders’ margins
Offering incentives eats into homebuilders’ profits — and Wall Street is taking notice.
Shares of homebuilder Hovnanian Enterprises have dropped 12% since the company reported earnings last week as investors fretted about the company’s shrinking margins. Around 72% of Hovnanian customers took advantage of a rate buydown offer in the company’s fiscal fourth quarter.
“Going forward, we expect to continue to use mortgage rate buydowns to help with affordability,” Chief Executive Officer Ara K. Hovnanian said on a call to discuss the company’s earnings last week.
Even Toll Brothers, which specializes in luxury homes and has a wealthy, less rate-sensitive clientele, isn’t immune to discounting. In an earnings report released this week, the company said it boosted incentives by an average of $12,000 per home in its fiscal fourth quarter in response to higher mortgage rates and buyers’ election jitters. Its forecast for gross margin missed analyst estimates, sending its stock sliding as well.
However, Toll executives said they plan to pull back on the incentives next year and raise home prices.
How much leverage homebuilders have to do so remains to be seen. They’re sitting on the highest level of unsold inventory since the financial crisis. There were about 116,000 new completed homes for sale in October, the most since July 2009.
At the same time, many would-be consumers haven’t seen their incomes keep pace with home price appreciation. New home prices remain near all-time highs, averaging $437,300 in October, up 36% from five years ago.
“While demand is there, it’s been challenging to get buyers because of the affordability issue,” said Crystal Sunbury, real estate senior analyst at RSM US.
