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A popular incentive for homebuyers is here to stay — for now

The housing market appears to be headed for recovery this year — assuming the Federal Reserve moves to cut interest rates as investors anticipate.

That raises the question for the country’s biggest homebuilders: Is it time to pull back on a popular incentive that many have offered to sweeten the deal for buyers in a tough market?

Over the past two years as the Fed raised rates, many builders leaned heavily on mortgage rate buydowns, where they cover a portion of the interest rate — usually a percentage point or two — that buyers pay on a loan for a specified period of time. The move to aid buyers, especially those purchasing a home for the first time, has squeezed builder profit margins despite helping to boost their sales.

Read more: Should you pay for mortgage discount points? 4 tips on how to decide.

So far, the biggest US homebuilder has signaled the mortgage rate buydown is here to stay, at least for now. D.R. Horton (DHI) CEO Paul J. Romanowski said on the company's first quarter earnings call in late January, “I believe on a go-forward basis, staying competitive to not only the new home market, but especially to the resale market for us, and the ability to have a lower monthly payment for the same cost of home is advantageous. So we have no plan in the near term to stop utilizing it even if we see rates shift down.”

Meanwhile, Lennar (LEN) co-CEO Jonathan Jaffe said on the company's fourth quarter earnings call in late December that “the reality [is] that none of us have a crystal ball at any moment in time to see which way rates or buyer enthusiasm is moving. As we sit here today, rates look better ... we don't know where they're going, but we're well positioned to just maintain that pace, which by definition means we would use lower-cost mortgage buydowns, and continue to drive the consistent pace.”

Builders' reluctance to abandon incentives could stem from fear of being the first mover, one analyst says.

“There is a reticence to pull back on incentives unless everyone is, because the fear is if you're first and you lose sales elasticity, then you're just going to have to put those incentives right back on,” Carl Reichardt, managing director and homebuilding analyst at BTIG, told Yahoo Finance in an interview.

Read more: Getting a mortgage with good (but not great) credit

Over the past two years, as the Fed raised rates many builders leaned heavily on mortgage rate buydowns, where they cover a portion of the interest rate on the loan for the buyer. (AP Photo/Damian Dovarganes)
Many builders leaned have heavily on mortgage rate buydowns, where they cover a portion of the interest rate on the loan for the buyer. (Damian Dovarganes/AP Photo) (ASSOCIATED PRESS)

Historically, the large publicly traded homebuilders have always offered some form of an incentive to sell homes. At times, it was a 2% to 3% discount of the selling price, Reichardt noted. But when rates started to climb, the affordability crisis was exacerbated, motivating builders to offer juicier incentives to close the deal.

One builder has hinted it will pull back from concessions like mortgage rate buydowns and instead sweeten the deal for buyers through other means. KB Home (KBH) will “reduce those incentives [and] take it to price" in the first and second quarters of this year, COO Robert McGibney said on the company's fourth quarter earnings call with analysts.

Fifty-eight percent of builders reported offering some form of an incentive in February, down from 62% in January and the lowest share since last August, according to the National Association of Homebuilders.

“The builders have all said that if they get the ability to bring the buydowns down, they will, because it seems like that is the most punitive on their gross margins at this point,” Jay McCanless, Wedbush’s senior vice president of equity research, told Yahoo Finance on the phone.

Dani Romero is a reporter for Yahoo Finance. Follow her on Twitter @daniromerotv.

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