A Beginner's Guide to 2-1 Buydown Mortgages

Lower your interest rate by 2%.

If you're considering buying a home soon, but need more money, consider taking out a 2-1 buydown mortgage. This loan lowers your interest rate over two to three years, which can help ease you into homeownership. Remember that this type of loan has some essential terms and conditions to be aware of, so be sure to talk to a lender about what's right for you.

How Does the 2-1 Buydown Work?

The borrower's interest rate is temporarily reduced during the first two years of the loan with a 2-1 buydown. This is accomplished by paying a lump sum at closing, known as "buydown points," by the borrower, lender, or a third party, which effectively lowers the interest rate on the loan.

A 30-year fixed-rate mortgage, for instance, might have an interest rate of 4% for the borrower, but with a 2-1 buydown, the rate might be lowered to 3% for the first two years. The interest rate rises to the initial 4% following the initial two years.

What Are the Guidelines for a 2-1 Buydown?

A temporary buydown is a financing tool used in real estate transactions to reduce the interest rate paid by the borrower for a set time period. The lender, seller, or builder is allowed to pay part of the interest on behalf of the borrower, which "buys down" the interest rate.
The borrower's monthly mortgage payments decrease for two years during the buydown period of a 2-1 buydown mortgage, which reduces every 1% interest rate. When the buydown period is over, the interest rate and monthly payments go back to what they were before, which was higher.

How to Calculate a 2/1 Buydown

Here's how to calculate the cost of a 2/1 buydown:

We'll assume a $300,000 loan amount at a 6%interest rate for a 30-year term.

To calculate the 2-1 cost, the lender will first calculate your principal and interest payment on the current interest rate (6% in this example).

The next step is to calculate the principal and interest payment based on a 2% interest rate reduction (4%). Subtracting the second-year payment from the 6% payment gives you the cost to buydown the interest rate for year one.

Repeat the same steps for year two, but use 5% to calculate the cost for year 2.

  Year 1 Payment
Current Interest Rate 6% $1,799
Interest Rate Reduced by 2% 4% $1,432
Monthly Savings $367
Yearly cost ($367 X 12 months) $4,404
 
  Year 2 Payment
Current Interest Rate 6% $1,799
Interest Rate Reduced by 1% 5% $1,610
Monthly Savings $189
Yearly cost ($189 X 12 months) $2,268
 
Total Buy-Down Cost ($4,404 + $2,268) $6,672

In return for a one-time fee that is given at the time of closing, a 2-1 buydown gives you the ability to temporarily decrease your interest rate for the first two years that you are a homeowner.

Who Pays for the Buydown?

The buyer can pay for it, but usually, it's the seller who does. If the seller agrees to pay for it, the price of the home will change to reflect that.
Gift funds are another choice. Do you have family or friends willing to help you buy a house? If someone gives you money as a gift, you should talk to your lender about how to send the money.

Can the Home Seller Pay the Buydown Cost?

Yes, the person selling the house can pay for the buydown, and this is called a "seller-funded buydown," and both the buyer and the seller can agree to it.

Calculate what assistance the seller can provide and how much money can be allocated towards your "buydown" costs for a conventional mortgage when purchasing a home by having a purchase agreement that states the total sales price and the down payment.

The lender can help determine how much the maximum sales discount will be, and the full-price offer can cover the buydown most of the time.

What Is the Qualifying Rate on a 2-1 Buydown?

For a 2-1 mortgage, borrowers must qualify based on the starting interest rate. Based on the previous example, the lender would be eligible for the borrower at 6%.

How Does a Buydown Benefit the Seller?

Offering a buydown concession can be a great way to sweeten the deal for buyers on the fence about your home. It can also help to speed up the selling process.

It is essential to discuss with both your real estate agent and mortgage lender if you are pondering a buydown of the interest rate to determine if it is suitable for your circumstances.

The Pros of a 2-1 Buydown Explained

  • Since your interest rate is lower for the first two years of homeownership with a 2-1 buydown, your monthly payment is also down.
  • Helps you adjust to paying mortgage payments monthly: Reduced mortgage payments for the first two years are one way to ease into homeownership. You'll learn the procedure quicker and save money if you do it this way.
  • Helps you save money during the first two years of homeownership: Because of the lower rate, you may avoid paying the extra in mortgage payments. You may do this to save money for other short- and long-term financial objectives.

The Cons of a 2-1 Buydown Explained

A 2-1 buydown has a few disadvantages. Applying the seller concession to closing costs instead of a 2-1 buydown can be beneficial. If a seller is willing to pay for a 2-1 buydown, they should also consider reducing the sales price.

What Are the Alternatives to a 2-1 Buydown?

  1. Adjustable-rate mortgages offer a low initial interest rate, and most adjustable-rate mortgages cap the interest rate by 2% annually and 5% lifetime.
  2. Borrow against your 401k or similar retirement savings.
  3. Discount points can lower the interest rate by 1/4% per point. A seller concession can significantly decrease the interest rate.

What Are the Requirements for a 2-1 Buydown?

To be eligible for a 2-1 buydown, you must have a good credit score and put down a minimum of 5% of the purchase price as a down payment.

You'll also need to pay closing costs.
A 2-1 buydown can reduce your monthly payments for the first two years of your loan. If you're strapped for cash or attempting to meet the requirements for a mortgage with a lower interest rate, this might provide you with some breathing space.

If you're considering a 2-1 buydown, talk to a mortgage lender to see if it's right for you.

FAQs About 2-1 Buydown Mortgage

Q. What are the benefits of a 2-1 interest rate buydown?
A. Consider a 2-1 buydown mortgage if you're in the market for a home. This loan reduces your interest rate for the first two years, resulting in lower monthly payments. After two years, the interest rate climbs to the regular rate for the rest of the loan. Take advantage of the lower payments for the first two years, then adjust to the higher payment for the remainder of the loan.

Q. Does a 2-1 buydown require extra funds at closing?
A. The 2-1 buydown does not require fees other than the interest rate buydown cost.

Q. How many points does a 2-1 buydown cost?
A. Discount points do not determine the buydown cost, but rather a simple arithmetic calculation to determine the cost to buydown the interest rate.
Q. What is the purpose of a 2-1 buydown?
A. The lower monthly mortgage payment gives the home buyer some payment relief for two years. The interest rates will roll back to where they were the last year, and the borrower can refinance to a lower interest rate.

Conclusion

A 2-1 buydown mortgage may be an excellent choice if you are in the market for a new home,

It allows for lower monthly payments and enables the buyer to build equity more quickly. This type of mortgage is also a good option for those who may not qualify for a traditional mortgage.

Read more questions and answers about conventional loans

SOURCE:
Temporary Interest Rate Buydowns
What is Required for the Treatment of Buydown Funds?

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