What is a 2/1 Buydown and how does it work?
A 2/1 Buydown is a financing technique that allows a borrower to have reduced monthly mortgage payments for the first two years of the loan term. With this option, the interest rate would be 2% lower for the first year and 1% for the second year. In the third year, the rate will go up to the note rate determined at the time the loan was closed.
Sound too good to be true? Well, it is not without some additional costs. While it is the borrower who directly benefits from the buydown loan with lower monthly payments, they are not always the one who pays for the buydown. The best-case scenario for the buyer will be if the seller, realtor, or builder agrees to pay the discount points at closing. Discount points are a one-time fee paid upfront to lower the interest rate. Said another way, a 2/1 Buydown loan is a simple fixed-rate mortgage where a portion of the payment is prepaid at closing.
How are points determined?
Points are calculated based on the loan amount. Each point equals one percent of the loan amount. The points are paid at closing and will increase the closing costs.
A 2/1 Buydown loan helps buyers who want to enter the home buying market but may not be able to afford the monthly mortgage payments comfortably based on current interest rates. A buydown loan could be a great option if a buyer has enough savings for a significant down payment and to pay closing costs with cash left over to pay for the buydown if it is buyer funded. As stated previously, the best situation for a homebuyer would be if the seller, realtor, or builder paid for the buydown as an incentive to purchase the home. Typically, you would see this more in a buyer’s market.
Who pays for the 2/1 Buydown?
- Buyers – A buyer would work with their loan officer to determine the cost of the buydown and the break-even point.
- Sellers – In a buyer’s market, sellers may agree to pay the discount points out of the proceeds of the sale of the home at closing as an incentive to sell their home quickly.
- Builders – Builders may agree to pay the points at closing as an incentive to purchase a new construction property.
- Realtor – Realtors may agree to take a reduced commission to help fund the buydown to facilitate the home sale.
There are some concerns with buydown loans. Namely, will a buyer be able to afford the new payment when the interest rate goes to the note rate in year three? Homebuyers who know they will have a significant increase in household income within the next three years may benefit from a 2/1 buydown loan. Some typical scenarios may include a stay-at-home parent returning to work, a graduate or medical resident completing their training within three years, and securing employment in their field of expertise.
What is your break-even point if your 2/1 buydown is buyer funded?
Calculating the breakeven point is done by taking the cost of the points and dividing it by the monthly savings.
Buydowns are only used for purchasing or refinancing a primary residence or second home. Typically, buyers must qualify for the loan at the current interest rate with no points to secure a buydown loan.
Remember that this program doesn’t buy down the rate but instead reduces the payment to what it would be at the lower rate. The 2/1 buydown loan is not for everyone, but if it works for you, you may be able to save on your monthly mortgage payments. In addition, the savings for the first two years can be used for other expenses. Find out more today!
