Despite unprecedented market conditions, home prices jumped 31.6 percent from May 2020 to January 2022 primarily because of the prevalence of remote work and historically low mortgage interest rates. Black and Latino homeownership rates also increased—even more than the white homeownership rate—which was especially significant because of the structural barriers households of color face and because the pandemic hit them disproportionately hard.

Today, the tables have turned. Even with some recent moderation, home prices remain elevated and interest rates have risen significantly, putting homeownership out of reach for many renters. The Federal Reserve will likely continue tightening monetary policy into 2023, which extends affordability concerns, especially for households of color, the majority of whom remain renters.

But research on Newark, New Jersey, suggests targeted interest buydowns, for extended periods or permanently over the mortgage life, could boost the purchasing power of households of color and quicken the pace at which they can build equity. Lenders, sellers, builders, and local governments are increasingly using mortgage rate buydowns, and loans with buydowns can be securitized within limits. Past and present public policy provide an opportunity for the federal government to facilitate buydown subsidies.

A lower interest rate boosts affordability and wealth equity

Let’s look at how interest rates and buydowns affect who can afford to buy a home.

According to the Federal Housing Finance Agency, the median home price in October 2022 was $392,700. This price, purchased with a 95 percent loan-to-value mortgage with a 6.9 percent interest rate, would result in a monthly principal and interest (P&I) payment of $2,457.

Assuming roughly that no more than 30 percent of income should be consumed by P&I payments means a household needs to earn $98,280 a year to afford this loan. But at a pandemic-level interest rate of 3 percent, all else equal, the payment of $1,572 means a household would need to earn $62,880 to afford the same home.

Today, 7.7 million renter households earn between $62,880 and $98,280, including 1.2 million Black renter households and 1.7 million Latino renter households. A rate buydown could maintain homebuying affordability for these households; nearly three times as many Black and Latino households as could afford the median home at a 6.9 percent interest rate.

Lower interest rates also allow for faster equity building and less drain on household finances. In this example, the first month’s payment under the lower-rate loan would include less than half as much interest ($933 versus $2,145) and more than twice as much principal paydown ($639 versus $312).

Structuring a rate buydown program

What would a rate buydown program cost? Using a duration multiplier of 5.5, each percentage point reduction would cost 5.5 percent up front.

The table below illustrates how Borrower A, earning $62,880 and making a 5 percent down payment ($15,579), could afford to buy a larger home with a 2 percentage-point buydown ($311,579) than Borrower B could with no buydown and the same income and funds ($254,079). Assuming both properties appreciate at the same pace, 3 percent a year in this example, Borrower A’s home will be worth about $360,000 in five years while Borrower B’s home will be worth less than $300,000.

The 11 percent subsidy (2 x 5.5) required is in the range of more generous down payment assistance (DPA) programs. The table also illustrates a scenario for Borrower C, who receives DPA of the same subsidy amount and a mortgage with the same monthly payment and the same amount of borrower funds down. Borrower C cannot afford to buy as much house as Borrower A, but starts with more equity. Yet a modest 3-percent-a-year home price increase results in higher absolute appreciation for Borrower A, and 12 years later, in this simplified scenario, the buydown borrower’s equity (Borrower A) reaches parity with the DPA borrower’s equity, all else equal. 

The Cost of a Deep Buydown versus Down Payment Assistance and No Subsidy at a $1,572 Monthly Payment with a $15,579 Down Payment

Source: Authors’ calculations.
Notes: DPA = down payment assistance. *Presumes DPA is 100 percent forgivable.

This is not to say one form of homebuying assistance is better than the other but rather that adding targeted, sustainable buydowns to the toolkit can improve affordability for households of color, in direct response to structural income disparities. Alternatively, the rates could be bought down less or for a shorter period (with a graduated step-up) or combined with DPA, depending on program goals and market conditions.

Building on precedent for a national mortgage buydown program

This is not a new idea. When home prices doubled from 1970 to 1976 and inflation reached over 11 percent in 1974, the Federal Reserve constrained credit, while the Nixon and Ford administrations took steps to buy down the effective interest rate on selected types of housing investments.

In 1970, the US Department of Housing and Urban Development instituted the first of a series of interest rate buydowns through “tandem plans,” under which Ginnie Mae bought specified types of mortgages at below-market interest rates, sold them through Fannie Mae and Freddie Mac at market prices, and footed the bill for the difference. Initially limited to select Federal Housing Administration–insured mortgages, with building permits at a nearly eight-year low, Congress, with the Federal Reserve’s informal approval,  temporarily expanded the Tandem Plan (PDF) in 1974 to include government-sponsored enterprise conforming mortgages.

Although boosting homebuyer purchasing power broadly can result in higher prices, a well-targeted program today would not raise the same inflationary concerns as the broad program of the 1970s. Policymakers could target assistance to residents of neighborhoods of color, first-generation homebuyers, or local public employees or through special purpose credit programs.

High interest rates have reduced homebuying affordability and slowed the momentum of homeownership growth and prospective equity build-up, especially for households of color. Targeted interest-rate buydowns have historical precedent and represent a timely way to sustain the purchasing power of households of color while sustaining them over the long term.