| Fred Goodwin, CMA 2007-08-31, 1:25 pm |
| Best way to sell house in buyer's market
<http://www.boston.com/realestate/ne...les/2007/08/27/
best_way_to_sell_house_in_buyers_market/>
http://tinyurl.com/2w2zz6
Consider rate buydowns when buyers are short on cash
By Jack Guttentag | August 27, 2007
These days, I hear many complaints from home sellers. Among them:
"It's been on the market for nine months with nary a nibble"; "I cut
the price three times, still hasn't sold"; and "Three other houses on
my block are up for sale, so I took mine down."
In a buyer's market, sellers not only compete with each other, they
are also in competition with builders. But builders have an advantage:
they have affiliations with lenders through whom they offer financial
inducements that most individual home sellers don't know about. Yet
the fact is that there is nothing that builders offer that individual
home sellers cannot match, provided they know how.
Typically, the first thing sellers think about doing to make their
houses more marketable is reduce the price. Very often, that doesn't
work, because the price is not the problem. If potential borrowers are
cash-constrained or income-constrained, a price reduction provides
very little help.
Here is an example. Jones has her house listed at $200,000, and
lenders will lend 95 percent of that at 6.5 percent on a 30-year fixed-
rate mortgage to a borrower with adequate income and good credit. The
cash-constrained borrower, however, can't come up with the $14,000 in
required cash, consisting of a $10,000 down payment plus (say)
settlement costs of $4,000.
If Jones cuts the sale price by 7.5 percent, or $15,000, the cash
required from the borrower drops from $14,000 to $12,950, or by a
measly $1,050. (These and other numbers below can be found in a
spreadsheet on my Web site). For this potential buyer, it makes far
more sense for Jones to pay the $4,000 in settlement costs, which
reduces required cash by $4,000.
Next, let's consider the case of an income-constrained buyer. The
income constraint may be imposed by lenders, who set maximum ratios of
income to expenses, or the constraint may be self-imposed, based on
what buyers believe they can afford.
The $15,000 price decrease, which reduces the loan amount from
$190,000 to $175,000, reduces the payment by $90.07, or 7.5 percent.
>From the seller's perspective, that is not a lot of bang for the buck.
A better option is to pay points to reduce the rate on the buyer's
mortgage, retaining the same sale price and loan amount. If the
interest rate on the $190,000, 30-year, fixed-rate loan were reduced
from 6.5 percent to 5.5 percent, the payment would fall by 10.2
percent. The cost to the seller would be about 4.6 points, or $8,740.
This is about 40 percent less than the price reduction needed to
reduce the payment by 7.5 percent.
Points paid to reduce the rate are sometimes termed a "permanent
buydown" because the lower rate and payment run for the entire life of
the loan. An even more powerful way to lower the payment is for the
seller to buy down the payment in the early years of the mortgage.
This is called a "temporary buydown" because the payment reduction
doesn't last.
On a 3-2-1 buydown, the mortgage payment in years one, two and three
is calculated at rates 3 percent, 2 percent and 1 percent,
respectively, below the rate on the loan. On a 2-1 buydown, the
payment in years one and two is calculated at rates 2 percent and 1
percent below the loan rate. And on a 1-0 buydown, the payment in year
one is calculated at 1 percent below the loan rate.
I will use a 2/1 buydown to illustrate because it is the most common.
Using the same mortgage as before, the payment in year one is
calculated at 4.5 percent, which is 2 percent below the 6.5 percent
rate paid the lender. The payment in year one is reduced by 19.8
percent, which is almost twice as large as the reduction with the
permanent buydown. In year two, the payment is reduced by 10.2
percent. And in year three it is back to what it would have been
without the buydown.
The total cost to the seller is $4,324, which is about half the cost
of the permanent buydown. The $4,324 is placed in an escrow account
from which monthly withdrawals are made. The total payment received by
the lender, consisting of the payment made by the borrower plus the
withdrawal from the escrow account is exactly the same as it would be
in the absence of the buydown.
WARNING: The buydown cost assumes the seller is not credited with any
interest on the buydown account. Don't fight about that; the interest
is reasonable compensation for setting up the arrangement. But some
lenders go beyond that and calculate the buydown amount on a 2/1 as 3
percent of the loan amount, which would increase the cost to $5,700.
(On a 3/2/1, they would charge 6 percent). This is a rip-off, which
you can avoid by making your arrangement through an Upfront Mortgage
Broker. Since their fee to the borrower is set in advance, they don't
profit from any such rip-offs and won't use a lender who practices
them.
The writer is professor of finance emeritus at the Wharton School of
the university of Pennsylvania. Comments and questions can be left at
http://www.mtgprofessor.com
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