Are you looking for a home loan with flexible rates? A 2-1 buydown mortgage might be something to consider. 2-1 buydown (sometimes spelled 2-1 “buy down” mortgages) is a unique type of payment arrangement.
For a short introduction to how mortgage buydowns work, check out the explanatory video. For a more comprehensive overview from Mortgage Mark, read on.
What is a 2-1 Buydown?
2-1 buydowns let you reduce your monthly mortgage payments for the first two years of the home loan. You might also see it described as a “2 1 buy down” or “2-1 buydown”, but it’s the same product.How Do 2-1 Buydowns Work?
It might look complicated, but don’t worry: it’s a simple arrangement.- For the first two years of the home loan, buyers pay lower monthly principal and interest (P&I) payments.
- During the first year, you pay a rate 2% lower than the actual P&I payments (hence the “2”).
- During the second year, you pay a rate 1% lower than the real P&I payments (the “1” in “2-1).
- After two years, you pay the actual monthly principal and interest payments.
How Are Buy Downs Possible?
They’re made possible by seller concessions. Essentially, the seller (in most cases, the home builder) pays some of the mortgage interest at closing. So, the seller covers the difference to allow the home buyer to pay less for two years. You’ll see this listed as a mortgage cost.Who Can Buy Down Mortgage Rates Help?
Home builders might offer 2-1 buydowns to encourage buyers to purchase a property. They’re helpful because they give new buyers more flexibility when buying a home. You’ll find 2-1 buydowns listed on various mortgage programs, including Federal Housing Association (FHA) loans.How Do I Calculate the Interest Rate for a Buy Down?
Mortgage Mark makes the process simple. To find out more about interest rates for buydowns, check out our calculator and explore your buydown options.Temporary 2-1 Buydown vs. Permanent Rate Buydown
To be clear, 2-1 buydowns do not reduce the interest rate permanently. They’re a temporary measure.
Permanently buying down the interest rate means that discount points are paid at closing to permanently reduce the interest rate. This obviously reduces the amount of interest paid over the life of the loan.
By contrast, a 2-1 buydown does not reduce the interest paid; instead, it allows the seller to prepay interest on the buyer’s behalf at closing. The mortgage servicer still receives payment of the amount due for the actual interest rate.
Who Qualifies for a 2-1 Buydown?
Anyone looking for a home loan can apply for a 2-1 buydown. However, you still need to qualify for the loan. So, what are the 2-1 buydown qualifications?
To get a 2-1 buydown, you must qualify for the mortgage at the full P&I rate. Meaning, you need to qualify based on your ability to pay the actual interest rate.
The temporarily lower payments for the first two years do not make mortgage underwriting easier. The borrower must use their qualifying income to receive approval on the potential full payment.
These are not “risky” loans like those from the past because a borrower must be able to qualify for the full payment before ever closing on the loan. Moreover, the homeowner knows exactly what the future payments will be before closing on the loan.
When Does a 2-1 Buydown Makes Sense?
A 2-1 buydown temporarily reduces the monthly mortgage payment obligation. There are a variety of reasons home buyers welcome this temporary relief.
Below are a few examples of when a 2-1 buydown may make sense for a home buyer:
- When future income is expected to increase; or
- When short-term expenses can soon be reduced; or
- When mortgage interest rates have risen dramatically and are projected to decrease in the future.
Always get financial advice before applying for a home loan if you’re unsure what’s right for you.
Future Income is Expected to Increase
The 2-1 buydown allows homeowners the flexibility to “grow” into their mortgage payments. Oftentimes, this can help young professionals with upward income growth, or for new employment positions that offer future incentives.
For example, Joe Buyer recently started a new sales job. He has a base income and will receive commission when he sells widgets. Joe Buyers expects his commission to increase as he builds his pipeline of customers in the coming years.
A 2-1 buydown makes great sense for Joe Buyer because the temporarily lower payments alleviate undue stress while his income grows.
Future Reduction of Expenses
2-1 buydowns can help if the home buyer has another financial obligation that will soon come to an end.
For example, if Joe Buyer has a student loan with a $500 per month obligation that he will pay off in two years, the buydown will allow the flexibility for Joe to focus on that debt and eliminate it during the first couple of years during homeownership.
2-1 buydowns can also help buyers meet the short-term financial obligations of actually buying a new home. The cost of moving, new furniture, and home décor can certainly impact the monthly budget during the first year of homeownership. The 2-1 buydown’s monthly payments provide some relief.
Potential Refinance with Lower Rates
There are future instances where experts project interest rates to decline. When inflation is high and the Fed is raising rates, mortgage interest rates typically run high as well. Later, after the Fed finishes raising rates and inflation cools, mortgage interest rates typically decline.
A 2-1 buydown allows homeowners to pay lower monthly payments during a time when interest rates are higher than future projections. A temporary buydown affords homeowners the luxury of lower payments while waiting for rates to come down for a potential refinance.
This scenario doesn’t present itself often, but it’s relevant when it’s present.
“Refund” for Refinancing (Within 2 Years)
If the initial home loan is refinanced within the first two years, the unused amount of the 2-1 concessions will be applied towards principal at time of the refinance closing. In other words, the unused funds reduce the mortgage debt and act as a principal payment when the refinance closes.
The reason for this is because the seller concessions belong to the homebuyer. The seller concessions cover the gap between the 2-1-buy-down-temporary payment and future permanent payment. Therefore, if not all 24 months of temporary payments are made, there will be an excess of funds that remain. That amount is owed to the buyer if the purchase mortgage is paid off before 24 months.
2-1 Buydown Costs
The costs for a 2-1 buydown are based on the principal and interest (P&I) payments of the potential home loan. The two factors that determine the costs are the interest rate and loan amount.
Below is an example for Joe Buyer’s purchase and the cost for his 2-1 buydown. Please note that this is an example.
This is NOT based on current market interest rates OR the APR. In addition, this is NOT indicative of any loan options available. In other words, please use this only as an example and don’t get all “legal” of me.
2-1 Buydown Parameters
Joe Buyer is purchasing a newly constructed home from a home builder for $500,000. Joe will put down 20% for his down payment. The interest rate on his loan will be 7.0% before applying any concessions or credits. (See above picture).
The builder is offering Joe $10,000 of seller concessions. Joe is considering how to use these funds for his closing costs payment methods.
Rate and Payment Structure
When using a 2-1 temporary buydown the payment for the first year will be based on a 5% interest rate (7% – 2% = 5%). Therefore, Joe’s payments will be $2,147.29 for the first year instead of $2,661.21 that should be charged for a 7% interest rate. (See above picture.)
Joe’s first year of payments are $513.92 lower because of the 2-1 buydown.
After 12 months the difference in interest paid between 5% and 7% is $6,167.08 ($513.92 x 12 months).
In year two the payments will be based on 6% (7% – 1% = 6%). In year two the P&I payments for a 6% rate rate will be $2,398.20 instead of the normal $2,661.21 at 7% interest.
Joe’s second year of payments are $263.01 lower because of the 2-1 buydown. After months 13 through 24, the difference in interest paid totals $3,156.09 ($263.01 x 12 months).
Buydown Costs = Unpaid Interest
The cost of the 2-1 buydown is the sum of the unpaid interest for the first two years. Over the first two years, Joe has “saved” $9,323.18 ($6,167 + $3,156) of interest.
This amount is the total amount the seller has a requirement to pay at closing to secure the 2-1 buydown. (See above picture.)
Joe can apply $9,323 of the builder’s $10,000 of seller concessions toward the buydown. In addition, Joe can use the remaining incentives for other purposes.
Who Pays for the Buydown?
The lender cannot contribute to the buydown, but the buyer can.
Note: not all lenders allow this so be sure to check with your Loan Officer before starting the process.
Alternatives to a 2-1 Buydown
Buy downs have pros and cons. On one hand, they help buyers meet the challenges of buying a new home. They can offer flexible financing solutions.
However, they’re not suitable for everyone. The temporary rate doesn’t last forever, and your credit score determines whether you’ll qualify.
There are 2-1 buydown alternatives to using seller concessions for a temporary buydown. Concessions can be used to permanently buy down an interest rate, pay for closing costs and prepaids, or reduce the sales price of the home. Please see closing cost payment methods for more details on these options.
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MortgageMark@MortgageMark.com
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