A type of loan that offers homebuyers a lower initial interest rate is coming back into fashion as lenders try to make home ownership more affordable amid high interest rates.
Known as a mortgage buyout, the loan typically involves a cash payment from the seller that effectively lowers the borrower’s mortgage interest rate for a limited time, usually two to three years, before it is due. back to full rate. The seller collects the money as the monthly mortgage is paid. That could give buyers struggling with high house prices and inflation for groceries and other goods a temporary respite from their monthly spending.
Lenders are offering buyout loans at a time when demand for mortgages is down due to high interest rates. The average interest rate on a conventional 30-year fixed mortgage fell to 6.61% for the week ending November 17, from 7.08% the previous week. But that’s still double the average rate of 3.1% a year ago.
This led to a drop in mortgage applications. Nationally, new residential mortgages in the third quarter were down 19% from the second quarter and 47% from the third quarter of last year, according to real estate information group ATTOM Data Solutions. This is the sixth consecutive quarterly decline.
Camden National Bank, one of Maine’s largest banks, is seeing a 50-70% drop in new home loans from peak activity, according to Renee Smyth, the bank’s chief experience and marketing officer. .
The bank is in the process of adding buyout loans to its mortgage offerings.
“It’s a benefit to the buyer because it helps the homeowner make mortgage payments easily,” she said. “The opportunity is for the homeowner to refinance their mortgage in two to three years, if interest rates go down.”
With a buyout loan, a borrower who wants a $400,000 mortgage at 7% for 30 years would pay 5% in the first year, or $2,147 per month, for example. That’s $514 in monthly savings, or more than $6,100 for that year.
In the second year, the interest rate would increase to 6% and the monthly payment would be $2,398, a savings of $263 per month and $3,156 for the year. In year three, the rate would revert to the original 7%, or $2,661 per month, for the remainder of the loan, giving it a hard cap.
The borrower’s savings come from the seller’s buyout money, which is set aside in an escrow account. Cynthia Veroneau, sales manager at Caliber Home Loans in Portland, said a seller might be willing to face the cash to create more buzz around the sale of their home, especially if it’s selling slowly. The money could also be used to pay closing costs.
That will make a big difference for a first-time home buyer, said Jennifer Tabb, associate broker at Portside Real Estate Group in Portland. His client was unable to complete the purchase of her newly built condominium in Westbrook because the utility company was slow to install a power supply. Meanwhile, the lock-in rate on his loan has expired and interest rates are now about 2 percentage points higher.
“It was supposed to close at the end of August, but the utility hasn’t completed its electrical installation,” Tabb said.
The client’s original 30-year loan was locked in at 5.625%, but when it expired in October mortgage rates had already risen to 7.625%. The client, who also had to leave her apartment because the building was sold, had to pay for short-term accommodation and storage of her belongings, adding unforeseen expenses.
Electricity is still not installed. When she is able to close the condo, the mortgage will help her replenish her savings and pay off her debt, Veroneau said. Caliber will provide the buyout loan at an as yet unspecified rate.
Even though buyout loans are short-term, they offer greater loan rate predictability than adjustable rate mortgageswhich also made a comeback when mortgage rates started to rise earlier this year, said Craig Mathieson, loan officer at Guild Mortgage in Falmouth.
Variable rate mortgages offer lower initial rates and are about 1 percentage point lower than current fixed rates. They attracted mortgage seekers who could potentially borrow more money due to the lower rate and qualify for a previously unaffordable home. At the end of their term, however, the rate is not known and could potentially increase significantly.
“Compared to an adjustable rate mortgage, you have caps on rate increases,” Mathieson said. “A buyout provides more predictability.”