What is a 2-1 Buydown?
A 2-1 Buydown is a type of financing that lowers the interest rate on a mortgage for the first two years before it rises to the regular, permanent rate. The rate is typically two percentage points lower during the first year and one percentage point lower in the second year. Then the third year, your rate reverts to the regular rate for the remainder of the life of the loan.
For instance, consider a developer of new homes who is offering a 2-1 Buydown. A homebuyer might obtain a mortgage with only 3% in the first year, 4% in the second year, and 5% after that if the current 30-year mortgage interest rate is 5%.
If the homebuyer took out a $200,000, 30-year mortgage, their initial monthly payments would be $843. They would pay $995 in the next year. Their monthly payment would increase to $1,074 at the conclusion of the second year and remain there for the duration of the mortgage.
Why Is This a Good Option?
You may think rates are too high right now, but by using a 2-1 Buydown, you get into your new home (and loan) at a lower interest rate at the start of the loan. “We often see homebuyers use the 2-1 Buydown to get into their new home, then wait to see what the Fed does with interest rates. If it becomes lower than the long-term rate of their loan, they refinance to the lower rate”, says Chris Coulter, Sr. Loan Officer at Southeast Mortgage in Blairsville.
How a 2-1 Buydown Works
With the aid of a Buydown, a borrower can more easily meet the requirements for a mortgage with a lower interest rate. When consumers pay more points to the lender up front, the cheaper rate frequently lasts for the life of the mortgage. However, it can also only apply for a specific amount of time. One type of temporary buydown, in this case lasting two years, is a 2-1 Buydown.
In a 2-1 Buydown, the interest rate will rise each year until year three, when it will stabilize at its permanent rate. Lenders will tack on an extra fee to make up for the interest they won't be getting in the initial years.
A Buydown can be funded by either a home seller or a property buyer. That payment could be made in the form of mortgage points or a lump sum placed with the lender in an escrow account to help cover the borrower's lower monthly payments.
2-1 Buydowns are frequently used by sellers to entice buyers, especially homebuilders.
2-1 Buydown Pros and Cons
A 2-1 Buydown can benefit house sellers by making it simpler and occasionally quicker for them to sell their properties for a fair price. The drawback, of course, is that it has a price, which ultimately lowers the amount of money they will make from the transaction.
A 2-1 Buydown may offer various advantages to homebuyers. One benefit is that it may enable them to afford a larger mortgage and a costlier home than they may otherwise be able to. “We often see homebuyers use this program to buy a home when they anticipate a higher income down the road,” says Coulter. Another benefit is that it gives them some breathing room before their mortgage payments increase to the full amount, which is beneficial if their income is also increasing over time.
The danger that purchasers' income won't keep up with those rising mortgage payments is a drawback. If so, they can become overextended and end up having to sell the house.
When to Use a 2-1 Buydown
If home sellers are having trouble selling and need to offer an incentive to find a buyer, they might want to think about providing (and paying for) a 2-1 Buydown.
If a Buydown enables borrowers to purchase the property they desire at a price they can afford, then they may benefit. They should also think about what might occur if their revenue doesn't increase quickly enough to cover their upcoming monthly expenses. Additionally, buyers should confirm that they are initially receiving a reasonable offer on the property. This is due to the possibility that some sellers will raise the asking price in order to cover the cost of the 2-1 buydown.
Be aware that not all lenders or certain state and federal mortgage programs may offer Buydowns. Fixed-rate Federal Housing Administration (FHA) loans are eligible for a 2-1 Buydown, but only for brand-new loans; refinancing is not permitted. Each lender may have a different set of terms.
Always consult with your lender to discuss your particular situation, your goals, and all of your options to see if a 2-1 Buydown is right for you. Every situation is different and so is every loan option. With careful consideration, your lender can suggest a loan that’s perfect for you!