How to Lower Your Interest Rate With a 2-1 Buydown Mortgage

Lower your interest rate by 2%.

Beautiful suburban homeIf you're thinking of buying a home soon, but don't have enough money for a full purchase yet, consider taking out a 2-1 buydown loan. This type of loan lowers your interest rate over a period of two to three years, which can help ease you into homeownership. Keep in mind that this type of loan has some important terms and conditions to be aware of, so be sure to talk to a lender about what's right for you.

How Does a 2-1 Buydown Work?

When you buy a home, the interest rate on your mortgage is one of the most important factors that will affect your monthly payment. If you can get a lower interest rate, your payments will be lowered.

To buydown the interest rate is one method of obtaining a lower rate. To achieve a reduced interest rate for the duration of your loan, you must pay more money upfront.

A common type of buydown is the 2-1 interest rate buydown. With this type of buydown, you pay 2% of the loan amount upfront.

The 2-1 buydown reduces the mortgage payment by 2% for the first year. The interest rate for year two is 1% less than the note rate. The buydown loans are usually fixed-rate for 30-years.

What Are the Requirements 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 period of time. The lender, seller or builder is allowed to pay part of the interest on behalf of the borrower, which “buys down” the interest rate.

This results in lower monthly mortgage payments for the borrower during the buydown period. After the buydown period expires, the borrower's interest rate and monthly payments will increase to the original, higher level. A 2-1 buydown means that for every 1% that the interest rate is reduced, it will remain at that level for two years before resetting to the higher rate.

How Much Does a 2-1 Buydown Cost?

Here's how to calculate the buydown cost:

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 it is more common for the seller to pay for it. If the seller pays for it, it will be reflected in the sales price of the home.

Another option is gift funds. Are your relatives or friends willing to help you with your home purchase? If someone gives you money as a gift, you should talk to your lender about how to send the money properly.

Can the Home Seller Pay the Buydown Cost?

Buyer and seller direction signsYes, the home seller can pay the buydown cost. This is known as a “seller-funded buydown.” The buyer and seller can agree on this sales concession. The total cost should be clearly stated in the purchase agreement.

The amount of the buyer's down payment for a conventional mortgage determines the maximum seller assistance and the amount of money that can be paid toward the buyer's buydown costs.

The typical way to pay for the buydown cost is to make a full-price offer, but with a sales' concession to cover the buydown. Check with the lender to calculate the maximum sales concession.

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 qualify 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 who are on the fence about your home. It can also help to speed up the selling process. If you are considering an interest rate buydown, be sure to talk to your real estate agent and mortgage lender to see if it makes sense for your situation.

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 lower.
  • Helps you adjust to paying mortgage payments on a monthly basis: Reduced mortgage payments for the first two years are one way to ease into homeownership. You'll learn the procedure more quickly and also 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

Emoticon with thumb downThere are a few disadvantages of a 2-1 buydown.

Instead of using the seller concession for a 2-1 buydown, that money could be applied to closing costs.

If a seller is willing to pay the 2-1 buydown costs, they should be willing to reduce the sales price.

What Are the Alternatives to a 2-1 Buydown?

  • Adjustable-rate mortgages offer a low initial interest rate, and most adjustable-rate mortgages cap the interest rate by 2% annually and 5% lifetime.
  • Borrow against your 401k or similar retirement savings.
  • Buydown the interest rate with discount points. One point usually reduces the interest rate by 1/4%. A strong seller concession can significantly reduce the current interest rate.

What Are the Requirements for a 2-1 Buydown?

To qualify for a 2-1 buydown, you'll need to have good credit and make a down payment of at least 5%. You'll also need to pay closing costs.

A 2-1 buydown has the benefit of reducing 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.

Rotating question markFrequently Asked Questions

Q. What are the benefits of a 2-1 interest rate buydown?
A. In a 2-1 buydown mortgage, the first two years of the loan have a reduced interest rate, and the subsequent two years have an interest rate that is greater for the remainder of the loan. This type of mortgage can be used to reduce the monthly payments for the first two years of the loan.

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

Q. How many points does a 2-1 buydown cost?
A. 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. Hopefully, the interest rates will roll back to where they were the last year and the borrower can refinance to a lower interest rate.

Read more questions and answers about conventional loans