How Potential Homebuyers Should Use Incentives Offered by Homebuilders

How to Use Builder Credits Properly

Builder credits are prevalent in today’s market, especially when interest rates are high and become a deterrent to potential buyers.

Below is a breakdown of how the Mortgage Mark Team most commonly recommends applying the builder credit. Every buyer and every loan is unique; therefore, please contact us to determine the best way to apply your builder credits.

Determine How Much Builder Credits are Allowed

When getting a mortgage to purchase a home, mortgage programs have limits on the amount of builder credits (also known as seller concessions). These limitations are based on the loan program and down payment percentages.

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How to Apply Builder Credits

There are three ways to apply builder credits:

Pay for closing costs, buy down the interest rate, and reduce the purchase price.

For VA loans, builder credits may also be applied to pay off a Veteran’s debt. This may not be something that all lenders are familiar with, so please call us and we’ll be happy to walk you through that process.

1. Pay Closing Costs

The first and most obvious application for builder credits is to apply them towards closing costs and prepaids. 

For example, a homebuyer may not need to pay any closing costs if a homebuilder is offering $7,500 in builder credit and the closing costs and prepaids total $6,000.

In this example, there would be $1,500 of builder credits remaining. Conversely, if the builder concessions are $5,000 and the total money due is $6,000, the homebuyer would need to pay the $1,000 that is not covered.

It’s also important to note that builder credits cannot go towards a buyer’s down payment.

2. Explore Lowering the Interest Rate

The next step with builder credits—assuming there is money remaining after paying all the closing costs and prepaids—is to explore buying down the interest rate.

Notice that Step 2 isn’t “Buy Down the Interest Rate.” The wording of “Explore Lowering the Interest Rate” is intentional. Buying down the rate isn’t automatic. 

Three things impact this step: the amount of builder credit, the current interest rates, and future projections of interest rates. The first thing the homebuyer needs to determine is what they think will happen to interest rates in the foreseeable future. 

If rates are projected to go higher in the next year or two, then a permanent rate may be appropriate. Conversely, if rates are expected to go down in the next year or two, then a temporary buydown may make sense. 

Permanent vs. Temporary Buydown

A permanent rate buydown is different from a temporary buydown. A permanent buydown is when money is spent at closing to reduce the interest rate permanently. This makes sense when rates are low and expected to increase.

The time to do a permanent rate buydown is when current interest rates are low and expected to increase. When rates are low, it makes sense to use the builder credit to lower the rate and preserve that rate for the future.

For example, a permanent rate buydown made sense during COVID when rates were incredibly low. It made sense to pay money at closing to reduce the rate since they were the lowest rates in history.

Using builder credits for a permanent interest rate buydown does NOT make sense when rates are expected to go lower in the future. The reason is because a homeowner can refinance to a lower rate in the future when rates dip.

Temporary Buydown

Paying for a permanent buydown with builder credits could be wasteful when a loan will be refinanced for a lower rate. The alternative is to do a temporary buydown when interest rates are high and are expected to be lower in the future.

Check out temporary buydowns for more details. Note: these are not ARMs. Something cool about temporary buydowns is that unused money for the buydown is credited to the homeowner if the loan is refinanced before the end of the buydown period. 

Something else to note is that a temporary buydown may not be feasible if there are not enough builder credits remaining after paying for the costs to close. Our loan amortization calculator can help determine the amount of costs for various temporary buydowns (like the 2/1 buydown). 

You can download it here, or contact us to create a personalized worksheet for you. 

If there are not enough builder credits remaining after paying for the cost to close, then the next step is to reduce the sales price.

3. Reduce the Purchase Price of the Home

Using the homebuilder credits to reduce the sales price is the last option. As mentioned above, use the builder incentives to pay all costs, then (if possible and if relevant) buy down the interest rate before reducing the sales price.

It may seem counterintuitive to use the builder credits to reduce the sales price as the final option; however, it is the financially prudent move.

Using the builder credits to cover the cost to close makes the most sense. Every dollar of the seller concessions used keeps another dollar in the homebuyer’s bank account.

Next, using the builder incentives to (properly) buy down the interest rate will save more money in the long term than reducing the sales price.

Builder Credits Conclusion

Obviously, a homebuyer wants to take full advantage of the builder credits. The best thing to do is use the seller concession to pay for the cost to close (excluding the down payment). Reducing the sales price should be the last thing that a homebuyer does with the builder incentives.

As always, please reach out to the Mortgage Mark Team if you have any questions about how to properly use builder credits. We’re here to help.