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I would like to better understand how the buydown works in residential housing market.

A typical situation that comes to my mind is that a developer who wants to get rid of excess supply of homes in an ailing housing market. Because the developer wants to get rid of these inventories before the prices drop further, she has the incentive to pay some sort of lump sum to the lender effectively reducing the interest rate on a mortgage.

My Question.

  1. How does this help to get rid of the excess inventory? In other words, why would borrowers "better" or more easily qualify for the loan if the developer does the buydown?

  2. Is there any winner or loser in the scenario? Does the commercial bank lender assume more risk in this case?

  3. Any interest feature associated with the buydown?

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    Here’s a writeup for those who are wondering why a seller would want to buy, and why a developer would be interested in mortgages. In brief as I understand the linked explanation: in a buydown, the seller effectively discounts the price by making payments to the buyer’s mortgage provider. – Lawrence Oct 2 at 15:49
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How does this help to get rid of the excess inventory? In other words, why would borrowers "better" or more easily qualify for the loan if the developer does the buydown?

Buy-downs were popular in the United States before the great recession because it made it easier for the buyer to get approved for the loan. The first years payment (which was reduced by the buy-down) was the one that they needed to qualify against. The subsequent years payments were not even considered during the approval process. The idea was that the buyer would sell or refinance before the payments were too big to handle, or they would get raises to be able to afford the payment.

I understand that these become rare after the recession, but I suspect they are becoming popular again.

Is there any winner or loser in the scenario? Does the commercial bank lender assume more risk in this case?

The risk is what happens when the full payments kick in. Before the recession prices went up during the initial years of the mortgage so the the risks were viewed as acceptable. But once the bubble burst people couldn't afford the mortgages. The risk is that the lender will have many foreclosures.

Any interest feature associated with the buydown?

The source of the buy-down could be a builder, a seller, a government sponsored plan for first-time home buyers. It could be in cooperation with a lender, or totally separate from the lender. some were programs that lower the rate and payment for a few years, others were like buying points and lasted for the life of the loan.

  • "or they would get raises to be able to afford the payment." SMH. There're criminal stupidity all around. – RonJohn Oct 2 at 13:34
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  1. In reality, buydown scheme doesn't help reduce property inventory during a housing slump. Because the bank will be wary to approve a higher mortgage amount. Ironically, it is widely used to encourage flipping during housing speculation booms. In which speculators are using the scheme as leverage to scoop many houses to flip. Here is how it works: one only afford to pay a monthly mortgage of $2000 in the normal scheme, can arrange 3 houses mortgage that only charge interests rate, e.g. $300 for each house in the first 3 years.

  2. Because it can be abused as speculative leverage tools, it will cause the property bubbles even bigger. In the best scenario, only a bunch of people bankrupt when the property bubbles burst. In the worst scenario, you will a magnificent collapse like Japanese asset price bubble, subprime mortgage crisis.

  3. It is up to the regulator to choose whether to curb the buydown leveraging activities. Most mortgage giver (i.e. financial institution) usually don't care about the consequences of a meltdown.

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