While some homebuyers pay 8% mortgage rates, others are wrangling steep discounts—and it’s creating a surprising surge in new home sales

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Curiously, however, new residential home sales surged in September while existing home sales all but completely froze because owners are reluctant to move and buy another home at a far higher mortgage rate. New-home sales rose 12.3% to an annual rate of 759,000 in September, up from 676,000 in the prior month, the Commerce Department said Wednesday. 

Since there are so few existing homes on the market, buyers find themselves having almost no choice but to buy new. Builders, also under pressure from high interest rates, are sweetening the pot, however, by offering discounted mortgages and other incentives. In fact, Devyn Bachman, senior vice president of research with John Burns Research and Consulting, credits these enticements as the “number one” driver for the rising new home sales figure last month.

“‘Incentive’ is just a big fancy word for discount, and what we’re seeing on that front is that it’s what’s creating a competitive advantage for the new-home market,” she tells Fortune. The mortgage rate buydown, the industry term for discounted mortgage rates, is the most “desired and most effective” incentive offered in the new-home market today, she adds. 

Independent sellers usually cannot match these types of incentives, typically offered by large builders like Lennar and Toll Brothers, Erin Sykes, chief economist at residential real estate brokerage firm Nest Seekers International, tells Fortune.

Mortgage rate buydowns explained

As high as mortgage rates may seem now, there’s little indication that they’ll drop significantly anytime soon—meaning in the next two to three years. Capital Economics, for example, released a report this week saying not to expect 6%-and-below mortgage rates until the end of 2025. 

Mortgage rates hovering around 8% are a stretch for many borrowers, which is why a mortgage rate buydown can be an enticing option for eager prospective homebuyers. There are a few different types of mortgage rate buydowns, Bachman explains, with full-term buydowns and temporary buydowns being the most popular options among builders. 

A full-term buydown is the more desirable option for buyers because the builder buys down the mortgage rate for the entire life of the loan. In other words, builders pre-pay the difference in interest between the market mortgage rate and the mortgage rate they’re offering, Bachman says. 

Currently, some builders are offering buydowns as low as 5%, mostly in “peripheral, emerging” markets, Sykes says. This includes places like Loxahatchee, Fla., and Boynton Beach, Fla., which are both within 30 minutes of Palm Beach.

During the past week, mortgage rates hovered around 8%, “so when you’re talking about buying into the [5% range] that’s a huge advantage for the new construction market,” Bachman says. For a temporary rate buydown, the builder still buys down the rate, but it’s not for the entire life of the loan. Rather, the builder would pay a lump sum to reduce the mortgage rate for the first one to three years of the loan. After that, buyers would be subject to higher mortgage rates. Many builders that offer these programs have partnerships with certain mortgage companies or have their own mortgage arm.

Other builder incentives

Builders are also offering other incentives, including covering up to tens of thousands of dollars in closing costs, which can be particularly helpful for first-time homebuyers who struggle to save up enough.

“That gets at the heart of the affordability issue that we’re seeing in the marketplace today,” Bachman says. “Like, I just can’t close because I don’t have the cash to do so.”

Builders have also started building more “spec” construction as opposed to “to-be-built” homes. This is important because rate locks can be “incredibly expensive,” Bachman says. Rate locks mean that the mortgage rate between the time of offer on the newly built home won’t change between the offer and the closing. However, a rate lock can cost 0.25% to 0.5% of a mortgage, amounting to potentially thousands of dollars in extra costs for buyers in the form of a cash deposit.

The to-be-built model, in which buyers choose their plot of land and all of the finishes on the home before construction starts, is traditional in homebuilding. The issue is that when it’s finally time to close the deal months down the line, mortgage rates may have risen. Rate locks can prevent this. 

However, with spec construction, builders start construction without having a buyer, and once finished (or near finished), they put the home on the market. That gives buyers a better idea of what their mortgage rate will be at the time of purchase.

“Honestly, to remain competitive in today’s new construction landscape, most builders are offering mortgage-rate buyouts paired with other incentives,” Bachman says. “Now, I will caveat this whole thing by saying, if we get to a place where the market starts to kind of halt, this is a riskier business model.” 

She continued: “Why? Because the builders are starting homes that there’s not necessarily a contract or a consumer attached to.”

While mortgage rate buydowns and other incentives may be responsible for rising new-home sales today, Dan Green, CEO of first-time homebuyer mortgage company Homebuyer.com, tells Fortune that there are other factors at play—including low existing home inventory. With so few existing homes on the market, buyers have few options but to pursue new construction.

“Incentives and buydowns may be playing a role, but the more likely reason why new construction home sales are surging is that it’s all that buyers can buy,” he says. “It’s too tough to find a home resale.”