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Seller Financing of Temporary Buydowns Part 1: Effects on Sale Prices of Homes

Report Acceptance Date: 
November 1992
Posted Date:   
November 30, 2007

A temporary buydown is one of many creative financing techniques which enjoyed growing popularity in the late 1970s and early 1980s. Under a typical temporary buydown, a homebuyer's mortgage payments during the early years of the mortgage are subsidized by the seller, who pays a portion of the mortgage payments that would otherwise be paid solely by the borrower. This arrangement is effected by the seller's funding an escrow account that is depleted as funds are used to supplement the payments made by the mortgagor to the lender.

Because a temporary buydown offers monetary benefits to the homebuyer, a homebuyer would be willing to pay more for a home offering a temporary buydown as a part of the sales transaction. Unless a similar buydown were offered as part of subsequent sales transactions, however, any financing premium capitalized into the original sales price of the home would not be recaptured at resale, a possibility leaving the mortgage insurer more vulnerable to loss in the event of foreclosure. Temporary buydowns may also increase the likelihood of mortgage default for two reasons. First, inability to recapture the financing premium in subsequent sales reduces the mortgagor's equity incentive not to default. Second, to the extent that loan underwriters compare initial housing expenses to income, buydowns that reduce initial mortgage expenses facilitate larger loans, resulting in higher housing expense burdens after the buydown subsidy has terminated.

These logical arguments suggesting at least partial capitalization and increased default activity are supported by indirect empirical evidence on related phenomena. Until now, however, direct evidence on the effect of buydowns has been unavailable. The purpose of this research is to begin to fill this empirical void by estimating empirically the extent to which house prices include the capitalized value of temporary buydowns. A companion report examines the effect of buydowns on default probabilities.

The two parts of the report can be downloaded using the following links: