Solid Strategies for Getting to Sold

These days, I hear many complaints from home sellers. Among them: "It's been on the market for nine months with nary a nibble"; "I cut the price three times, still hasn't sold"; and "Three other houses on my block are up for sale, so I took mine down."

In a buyer's market, sellers must compete with one another, as well as with builders. But builders have an advantage: They have affiliations with lenders through whom they offer financial inducements that most individual sellers don't know about. Yet there is nothing that builders offer that home sellers cannot match, provided they know how.

Typically, the first thing sellers think about doing to make their houses more marketable is reduce the price. Often, that doesn't work because the price is not the problem. If borrowers are cash-constrained or income-constrained, a price reduction provides little help.

For example: Jones has her house listed at $200,000, and lenders will offer 95 percent of that at 6.5 percent on a 30-year, fixed-rate mortgage to a borrower with adequate income and good credit. The cash-constrained borrower, however, cannot come up with the $14,000 in required cash, to cover a $10,000 down payment and settlement costs of 2 percent of the price, or $4,000.

If Jones cuts the sale price by 7.5 percent, or $15,000, the cash required from the borrower drops from $14,000 to $12,950, a measly $1,050 difference. For this buyer and seller, it makes far more sense for Jones to pay the $4,000 in settlement costs.

Next, let's consider the case of an income-constrained buyer. The income constraint may be imposed by lenders, who set maximum ratios of income to expenses, or it may be self-imposed, based on what buyers think they can afford.

The $15,000 price decrease, which in this case reduces the loan amount from $190,000 to $175,000, reduces the payment by $90.07, or 7.5 percent. From the seller's perspective, that is not a lot of bang for the buck.

A better option is to pay points to reduce the rate on the buyer's mortgage, retaining the same sale price and loan amount. If the interest rate on the $190,000 30-year, fixed-rate loan were reduced from 6.5 percent to 5.5 percent, the payment would fall by 10.2 percent. The cost to the seller would be about 4.6 points, or $8,740.

Points paid to reduce the rate are sometimes called a permanent buydown because the lower rate and payment run for the life of the loan. An even more powerful way to lower the payment is for the seller to buy down the payment in the early years of the mortgage. This is called a temporary buydown.

On a 3-2-1 buydown, the mortgage payment in years one, two and three is calculated at three, two and one percentage point, respectively, below the rate on the loan. On a 2-1 buydown, the payment in years one and two is calculated at rates two percentage points and one percentage point below the loan rate. On a 1-0 buydown, the payment in year one is calculated at one percentage point below the loan rate.

I will use a 2-1 buydown to illustrate because it is the most common. Using the same mortgage as before, the payment in year one is calculated at 4.5 percent, compared with the 6.5 percent rate paid the lender. The payment in year one is reduced by 19.8 percent, which is almost twice as large as the reduction from the permanent buydown. In year two, the payment is reduced by 10.2 percent. And in year three, it is back to what it would have been without the buydown.

The total cost to the seller is $4,324, which is about half the cost of the permanent buydown. The $4,324 is placed in an escrow account from which monthly withdrawals are made. The total payment received by the lender, consisting of the payment made by the borrower plus the withdrawal from the escrow account, is the same as it would have been in the absence of the buydown.

Warning: The buydown cost assumes the seller is not credited with any interest on the buydown account. Don't fight about that; the interest is reasonable compensation for setting up the arrangement. But some lenders go beyond that and calculate the buydown amount on a 2-1 as 3 percent of the loan amount, which would increase the cost to $5,700. (On a 3-2-1, they would charge 6 percent.) This is a rip-off, which you can avoid by making your arrangement through someone certified as an "upfront mortgage broker," who has elected to do business in a transparent way. Because the fee to the borrower is set in advance, these brokers don't profit from such rip-offs and won't use a lender who practices them.

Jack Guttentag is professor of finance emeritus at the Wharton School of the University of Pennsylvania. He can be contacted through his Web site,http://www.mtgprofessor.com.

? 2007 Jack Guttentag

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