A 2/1 buy down (pronounced “two one buy down”) means that your mortgage interest rate starts two percent (2%) below the actual rate. That “teaser rate” is only for the first year of the loan.
A mortgage interest rate “buy down” means that money is paid at closing to temporarily lower the mortgage interest rate (and the monthly payment). The interest rate and the monthly mortgage payments will increase over time until the actual, permanent interest rate is reached.
The interest rate during the second year is one percentage (1%) lower than the actual rate. This means that the monthly mortgage payments won’t be based on the actual permanent interest rate until year three.
2/1 buydowns are not very common. The reason why is because the upfront costs are substantial. Moreover, they don’t offer much of an advantage. The costs due at closing are equal to the “savings” during the first two years of lower monthly payments.
Joe Buyer is purchasing a newly constructed home and the builder is offering XXX in seller concessions. Joe is going to use these funds for a 2/1 buy down. Let’s assume Joe Buyer’s actual interest rate is 5.0% before the 2/1 buy down.
When using a 2/1 buydown the payment for the first year will be based on a 3% interest rate (5 – 2 =3). Therefore, Joe’s payments will be XXX (instead of YYY) for the first year.
In year two the payments will be based off 4% (5 -1 = 4). The payments in year two will be XXX instead of YYY.
Joe has “saved” XXX in the first two years of his mortgage payments. It’s no coincidence that the total amount paid at closing for the 2/1 buydown will be XXX.
In most cases the seller will pay for the costs of the buydown.
Buy Down vs. Buying Down
Buying down the interest rate is different than an interest rate buy down. As mentioned, a buy down is method to temporarily lower the interest rate. By contrast, buying down the rate means that discount points are paid at closing for a lower interest rate.
A 2/1 mortgage buy down is typically (?) employed when buying new construction. Builders will often use the 2/1 interest rate buy down as a form of marketing. It’s a way to attract potential buyers to consider purchasing their home over another.
When to Use
Buydowns are often used when income is expected to increase in the coming years.
For example, Joe Buyer recently started a new sales job. He has a base income and will receive commission when he sells products. Joe Buyers expects his commission to increase as he builds his pipeline of customers.
The 2/1 buy down will allow Joe Buyer the flexibility to “grow” in to his payments.