Mortgage rates are at their highest levels in 22 years and house prices are at record highs. Hardworking people cannot get on the property ladder, and retirees are struggling to sell in order to downsize. The Biden administration has done little to help alleviate the problem. This Washington Examiner series, Home Economics, will investigate how we got here, the toll on people around the country, and the alternatives people are embracing to survive the market. The last part of this four-part series focuses on the alternatives to traditional fixed-rate mortgages gaining new consideration among prospective home buyers.
The era of mortgage rates over 7% has increased interest in alternatives to traditional financing.
A 30-year fixed-rate mortgage is not the only way to get into a home. Creative home buyers, sellers, bankers, and real estate agents can come up with a range of other strategies. So far, the market has not seen a major uptake of nontraditional financing arrangements, but that could change if interest rates stay high into next year.
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“I would absolutely expect those kinds of alternatives to increase,” said Mike Simonsen, president of the real estate analytics firm Altos Research.
Here are some of the alternatives:
ADJUSTABLE-RATE OR OTHER NONTRADITIONAL MORTGAGES
Adjustable-rate mortgages have grown in popularity this year as prospective buyers bet that interest rates can’t stay this high forever.
Adjustable-rate mortgages generally come with a set interest rate for a defined period at the beginning of the loan term, which is often lower than rates otherwise. If rates fall generally during that time, the borrower could refinance to the lower rate. Or, if rates fell later toward the end, the rate would adjust downward automatically.
The share of new mortgages that include adjustable rates, either from the beginning or after a period with a “teaser” rate, grew from 3% in 2021 to 11% this year, according to data provided by the National Association of Realtors.
Those shares overstate the popularity of adjustable-rate mortgages, though, because overall mortgage applications have fallen off.
“So it’s not a story about adjustable-rate mortgages increasing, it’s more so a story of fixed-rate mortgage applications declining faster than adjustable-rate mortgages,” said Orphe Divounguy, senior economist at Zillow Home Loans.
In terms of whether taking on an ARM is a good move, Divounguy said it really depends on the homebuyer’s “risk tolerance.” If someone takes on an ARM anticipating that mortgage rates will fall in the future but they end up going higher, it could cause serious financial strain.
“We have no idea where mortgages are heading,” Divounguy said.
It is also worth noting the difference between the rates on a 30-year fixed-rate mortgage and the lower initial rate offered by an ARM. As of Wednesday, the average rate on a 30-year fixed-rate mortgage was 7.07%, while an ARM with a five-year fixed-rate period of the mortgage followed by annual interest rate adjustments was 6.67%, according to Mortgage News Daily.
BUILDER BUYDOWNS
To get buyers into new construction, buyers have been offering “buydowns,” in which they offer to pay lenders a lump sum upfront to lower rates for buyers.
For example, builders might contribute 5%-6% of the home purchase price upfront to lower the 30-year mortgage rate by 1%-2%.
Doing so allows builders to keep sales high without lowering prices too much, keeping volume relatively high in the market for new construction — which has been the bright spot in the market throughout the past year.
“Builders have been using buydowns as an incentive, which has made new construction attractive to borrowers,” said Molly Boesel, principal economist at CoreLogic.
A third of homebuilders reported using buydowns in November, according to the National Association of Homebuilders.
Still, only a small percentage of borrowers buy down their rate, Boesel noted.
SELLER FINANCING
Seller financing, or owner financing, works by having the current homeowner, instead of a bank, act as the lender.
Cutting out the intermediary may help buyers save by getting more favorable terms from an owner motivated to sell, or by lowering closing costs.
It is difficult to get data on the use of seller financing because it occurs between private parties. However, brokers say they have seen a rise in the use of the nontraditional financing method in recent months, and the number of listings mentioning some form of private financing has risen, according to Realtor.com.
ASSUMABLE MORTGAGES
Some mortgages allow buyers to assume the debt, meaning that a buyer can take on the owner’s mortgage rather than taking out a new purchase mortgage of their own.
In other words, the buyer would take on the seller’s debt and pay them any difference between the sale price and the remainder of the mortgage.
Given that most extant mortgages have rates far below market rates, such an option would be attractive to buyers if it is available. Almost two-thirds of all mortgages have rates below 4%, and 90% have rates below 6%, according to Freddie Mac.
Most conventional mortgages are not assumable, but ones backed by the Federal Housing Administration, Department of Veterans Affairs, and Department of Agriculture are.
Assumable mortgages are a “hot topic,” according to the Intercontinental Exchange’s October mortgage monitor. Still, fewer than a quarter of existing mortgages are assumable, and a major obstacle to buyers assuming sellers’ debt is that many homeowners are reluctant to sell at all because to buy a new home, they’d need to take out a new loan at today’s much higher rates.
CASH
“The share of purchases made without a mortgage, AKA cash sales, is on the rise,” Boesel said.
The share of home purchases without a mortgage rose from 35% in 2021 to 38% this year, she said.
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Partly, that reflects increasing home purchases by investors. The role of hedge funds and private equity firms buying single-family homes has drawn notable scrutiny, including from members of Congress, but Boesel said another factor is that homeowners with lots of equity may be cashing in to make large down payments or using all cash to purchase another home.
It is worth noting that the share of homes owned mortgage-free has also been rising over the past decade, from 34% to nearly 40%, according to Census data analyzed by Bloomberg.
