Written by Elizabeth Madlem, Vice President of Compliance Operations and Deputy General Counsel at Bankers Alliance
“Keep it long enough and it will come back into fashion.”
The early 2000s are remerging with their crop tops, low rise jeans, flip phones, and mortgage buydowns. Deja-vu! Pre-crisis’ teaser rates have been reborn into mortgage buydowns, both temporary and permanent. With the housing markets remaining pricey, and rates still higher than they have been in years, many buyers are looking for assistance in any form. And as the refinancing market cools down, mortgage originators are becoming increasingly more creative finding innovative ways to bring business through the door. And this has led to lender, builder, and seller concessions to help close deals.
Buydowns generally are going to refer to when a borrower pays “points” upfront to reduce the mortgage rate to a level that places their monthly payments in a range they can afford. It is thought that the rate has been “bought down” from its original rate for the entirety of the mortgage by paying a lumpsum upfront. The more recent trend has been for these to be seller-paid rate buydown concessions, with the seller offering to reduce to buyer’s mortgage interest rate for either the first few years (temporary) or for the duration of the loan (permanent). The seller is either contributing to the buyer’s closing costs or paying for a temporary rate buydown.
What the market is seeing now is an influx of temporary buydowns, with the most common ones being a “2-1” and “1-0,” meaning a 2-percent interest rate reduction in the first year and a 1-percent interest rate reduction in the second year, or a 1-percent interest rate reduction in the first year only, respectively. Sellers, builders, lenders, or a combination of all three put-up money to cover the difference in interest rate payments between the original mortgage rate and the reduced mortgage rate. So for a 2-1 example, the mortgage rate is reduced by 2% for the first year and then will step up by 1% in the second year, and another 1% in the third year to reach the actual mortgage rate at origination. It essentially works as a subsidy for the first two years of the mortgage before reverting to the full monthly payment. And the benefits are there for consumers—it can make purchasing a home more affordable (even if temporarily) and can “buy time” for borrowers to refinance into a lower rate should interest rates fall.
With permanent rate buydowns, generally, it will be a seller paying a portion of the buyer’s closing costs that are used towards buying mortgage discount points, with each point reducing the rate on average by about 0.25 percentage points, costing 1% of the loan amount. So if a borrower bought a $500,000 home with a 20% down payment, the mortgage amount would be $400,000, with each point costing $4,000. With permanent buydowns, borrowers are historically slower to refinance given the cost/benefit decisions taking place with recouping upfront money put down for the loan versus refinancing costs associated with a new loan.
But one of the biggest issues with buydowns, either temporary or permanent, is proper disclosure on the Loan Estimate (LE) and Closing Disclosure (CD). For disclosure purposes, there are specific Regulation Z contemplated buydowns: third-party buydowns reflected in a credit contract; third-party buydowns not reflected in a credit contract; consumer buydowns; lender buydowns reflected in a credit contract; lender buydowns not reflected in a credit contract; and split buydowns (see 12 CFR 1026, Supp. I, Paragraph 17[c][1]—3 through 5).
Regulation Z provides numerous scenarios that determine whether the terms of the buydown should be reflected in the LE and CD. Generally, the following buydowns are reflected in the disclosures: third-party buydowns reflected in a credit contract; consumer buydowns; lender buydowns reflected in a credit contract; and split buydowns (consumer portion only). Otherwise, a third-party buydown not reflected in a credit contract, a lender buydown not reflected in a credit contract, and a split buydown (not third-party e.g.- seller’s portion) are not included.
With most of the criteria for determining whether a buydown is reflected on the LE and CD being dependent upon a credit contract, it is important to note that Regulation Z does not define a credit contract. But it is stated as being a contract that forms a legal obligation between the creditor and the consumer, as determined by applicable State law or other law.
So whether or not a buydown agreement would be considered a credit contract or legal obligation between the creditor and consumer depends upon what “State law or other law” consider to be a legal obligation. Whether a buydown agreement is actually modifying the terms of a note or contract is going to depend on how it is structured and whether that note or contract ultimately is reflecting that lowered interest rate. Counsel should be included in any final determinations, as well as investor requirements.
So where should the terms of the buydown be reflected in the LE and CD? Unfortunately the commentary does not provide an “item-by-item” list of what parts of the LE and CD the buydown should be reflected in. The key requirement to remember is that if the buydown is required to be reflected, it must be reflected in the finance charge and all other disclosures affected by it. That includes the “Finance Charge” on page 5 of the CD (except for seller-paid buydown fees as those are considered seller’s points); the “Annual Percentage Rate” on page 3 of the LE and page 5 of the CD; the “Projected Payments” table on the first page of the LE and CD; and the “Product” on the first page of the LE and CD reflecting a step rate.
There are different ways proper disclosure can be done dependent upon the specific loan scenario. Sometimes a buydown is money going to the borrower from the seller, while other times it is money going to the bank from the seller. These would be disclosed differently. So, the first question to ask: Who is giving money to whom, and for what purpose?
A more common scenario for temporary buydowns is where the buydown is seller paid and is not being reflected in the note or credit agreement as it is contracted for between the buyer and the seller. How is this properly disclosed? Well, the most common way to disclose this, since it is not reflected in the note or credit agreement, is to disclose this as a Seller Credit. Since this is not considered discount points that either the buyer or the seller are paying to the bank, the bank would not disclose in Section A. The bank is not involved in the scenario where a buydown agreement is solely between the borrower and the seller. Rather, the regulation and commentary do not specify that this must be disclosed in any particular way, so it is viewed generally as just a concession from the seller, which has multiple ways of compliant disclosure. Disclosing as a Seller Credit as noted above being the more common. This would be found in the Calculating Cash to Close Tables (LE & CD) and also in Section L on the CD, as it is not a credit that is paying any specific fee listed on page 2 of the disclosure. It could also be disclosed in Section N of the CD as a seller credit due at closing.
If it is a situation where the buydown funds are from the seller to the bank, it would be disclosed in Section A in the Seller Paid column, and not Section H because the recipient of Section H fees are third parties, and the bank is the one receiving the fee. In this instance, the money from the seller is specifically being used to buy down the rate, which is a Section A fee, since that is paid to the bank.
There are other arrangements in which the seller just gives the borrower some money to make up the difference in what the borrower is paying between Rate A and Rate B with no actual buydown of the rate taking place. This is a Section N disclosure. But in the instance in which the bank will actually be the recipient of the fee, and the fee from the seller is to pay for a specific loan cost, it should be disclosed in Section A.
The remix is happening—the early 2000s are repeating themselves. But even more so now with the increased examiner focus and scrutiny on consumer harm, it is important to make sure the bank is aggressively reviewing its buydown loan programs for the risks they can bring: reputational, compliance, legal, credit, and fair lending, and diligently documenting justifiable business decisions, reviewing investor requirements, and examining for proper disclosure and fair lending implications.