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Why Don’t Home Builders Lower Prices If Mortgage Rates Are Way Higher?

March 7, 2024

Lately, mortgage rates have surged higher, climbing from as low as 2% to over 8% in some cases.

Despite this, home builders have been enjoying healthy sales of newly-built homes.

And somewhat incredibly, they haven’t had to lower their prices in many markets either.

The question is how can they continue to charge full price if financing a home has gotten so much more expensive?

Well, there are probably several reasons why, which I will outline below.

Home Builders Don’t Have Competition Right Now

The first thing working in the home builders’ favor is a lack of competition. Typically, they have to contend with existing home sellers.

A healthy housing market is dominated by existing home sales, not new home sales.

If things weren’t so out of whack, we’d be seeing a lot of existing homeowners listing their properties.

Instead, sales of newly-built homes have taken off thanks to a dearth of existing supply.

In short, many of those who already own homes aren’t selling, either because they can’t afford to move. Or because they don’t want to lose their low mortgage rate in the process.

This is known as the mortgage rate lock-in effect, which some dispute, but logically makes a lot of sense.

At the same time, home building slowed after the early 2000s housing crisis, leading to a supply shortfall many years later.

Simply put, there aren’t enough homes on the market, so prices haven’t fallen, despite much higher mortgage rates.

They Don’t Need to Lower Prices If Demand Is Strong

There’s also this notion that home prices and mortgage rates have an inverse relationship.

In that if one goes up, the other must surely come down. Problem is this isn’t necessarily true.

When mortgage rates rose from record lows to over 8% in less than two years, many expected home prices to plummet.

But instead, both increased. This is due to that lack of supply, and also a sign of strength in the economy.

Sure, home buying became more expensive for those who need a mortgage. But prices didn’t just drop because rates increased.

History shows that mortgage rates and home prices don’t have a strong relationship one way or the other.

Things like supply, the wider economy, and inflation are a lot more telling.

For the record, home prices and mortgage rates can fall together too!

Lowering Prices Could Make It Harder for Appraisals to Come in at Value

So we know demand is keeping prices mostly afloat. But even still, affordability has really taken a hit thanks to those high rates.

You’d think the home builders would offer price cuts to offset the increased cost of financing a home purchase.

Well, they could. But one issue with that is it could make it harder for homes to appraise at value.

One big piece of the mortgage approval process is the collateral (the property) coming in at value, often designated as the sales price.

If the appraisal comes in low, it could require the borrower to come in with a larger down payment to make the mortgage math work.

Lower prices would also ostensibly lead to price cuts on subsequent homes in the community.

After all, if you lower the price of one home, it would then be used as a comparable sale for the next sale.

This could have the unintended consequence of pushing down home prices throughout the builder’s development.

For example, if a home is listed for $350,000, but a price cut puts it at $300,000, the other homes in the neighborhood might be dragged down with it.

That brings us to an alternative.

Home Builders Would Rather Offer Incentives Like Temporary Buydowns

Instead of lowering prices, home builders seem more interested in offering incentives like temporary rate buydowns.

Not only does this allow them to avoid a price cut, it also creates a more affordable payment for the home buyer.

Let’s look at an example to illustrate.

Home price: $350,000 (no price cut)
Buydown offer: 3/2/1 starting at 3.99%
Year one payment: $1,335.15
Year two payment: $1,501.39
Year three payment: $1,676.94
Year 4-30 payment: $1,860.97

Now it’s possible that home builders could lower the price of a property to entice the buyer, but it might not provide much payment relief.

Conversely, they could hold firm on price and offer a rate buydown instead and actually reduce payments significantly.

With a 3/2/1 buydown in place, a builder could offer a buyer an interest rate of 3.99% in year one, 4.99% in year two, 5.99% in year three, and 6.99% for the remainder of the loan term.

This would result in a monthly principal and interest payment of $1,335.15 in year one, $1,501.39 in year two, $1,676.94 in year three, and finally $1,860.97 for the remaining years.

This assumes a 20% down payment, which allows the home buyer to avoid private mortgage insurance and snag a lower mortgage rate.

If they just gave the borrower a price cut of say $25,000 and no mortgage rate relief, the payment would be a lot higher.

At 20% down, the loan amount would be $260,000 and the monthly payment $1,728.04 at 6.99%.

After three years, the buyer with the higher sales price would have a slightly steeper monthly payment. But only by about $130.

And at some point during those preceding 36 months, the buyer with the buydown might have the opportunity to refinance the mortgage to a lower rate.

It’s not a guarantee, but it’s a possibility. In the meantime, they’d have lower monthly payments, which could make the home purchase more palatable.

Home Price Cuts Don’t Result in Big Monthly Payment Savings

Price Cut Payment
Post-Buydown Payment
Purchase Price $325,000 $350,000
Loan Amount $260,000 $280,000
Interest Rate 6.99% 6.99%
Monthly Payment $1,728.04 $1,860.97
Difference $132.93

At the end of the day, the easiest way to lower monthly payments is via a reduced interest rate.

A slightly lower sales price simply doesn’t result in the savings most home buyers are looking for.

Using our example from above, the $25,000 price cut only lowers the buyer’s payment by about $130.

Sure, it’s something, but it might not be enough to move the needle on a big purchase.

You could take the lower price and bank on mortgage rates moving lower. But you’d still be stuck with a high payment in the meantime.

And apparently home buyers focus more on monthly payment than they do the sales price.

This explains why home builders aren’t lowering prices, but instead are offering mortgage rate incentives instead.

Aside from temporary buydowns, they’re also offering permanent mortgage rate buydowns and alternative products like adjustable-rate mortgages.

But again, these are all squarely aimed at the monthly payment, not the sales price.

So if you’re shopping for a new home today, don’t be surprised if the builder is hesitant to offer a price cut.

If they do offer an open-ended incentive that can be used toward the sales price or interest rate (or closing costs), take the time to consider the best use of the funds.

Those who think rates will be lower in the near future could go with the lower sales price and hope to refinance. Just be sure you can absorb the higher payment in the meantime.

Read more: Should I use the home builder’s lender?

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