2-1 Buydown Loan: Lower Your Interest Rate

Three people holding up a sign that says “interest rates.” Are you looking to cut costs on your mortgage loan? The innovative 2-1 Buydown Loan may be the answer you're looking for. Designed to lower your interest rate and, ultimately, the total cost of the loan, this option is a great way to reduce expenses over the life of your mortgage. Sometimes called a 3-2-1 buydown mortgage, the 2-1 Buydown Loan is simple to grasp and has many benefits for borrowers. Let's discuss how it works and how you can best calculate the cost of the 2-1 buydown option.

How Does the 2-1 Buydown Work?

A 2-1 buydown temporarily lowers the loan interest rate during the first two years. The borrower, lender, or a third party funds the buydown by paying a lump sum at closing, known as "buydown points."

For example, a 30-year fixed-rate mortgage with a starting interest rate of 4% for the borrower can become 2% in the first year and 3% in the second year through the 2-1 buydown. After two years, the interest rate returns to its original 4%.

What Are the Guidelines for a 2-1 Buydown?

Through a financing strategy known as a temporary buydown, the borrower temporarily lowers their monthly mortgage payments in real estate transactions. By covering a portion of the interest on the borrower's behalf, the lender, seller, or builder may be able to "buy down" the interest rate.

The borrower's monthly payments drop for two years with a 2-1 buydown mortgage as the interest rate drops by 1% annually. The interest rate and monthly payments revert to their previous levels after the buydown term ends.

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 calculating the principal and interest payment based on a 2% interest rate reduction (4%).

Subtracting the second-year amount from the 6% payment gives you the cost to buy down the interest rate for year one.

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

Loan Amount	$100,000	Year 1 Payment
Current Interest Rate	6%	$599.55
Interest Rate Reduced by 2%	4%	- $477.42
Monthly Savings		= $122.13
Yearly cost ($367 X 12 months)		$1,465.56

Loan Amount	$100,000	Year 2 Payment
Current Interest Rate	6%	$599.55
Interest Rate Reduced by 1%	5%	- $536.82
Monthly Savings		= $62.73
Yearly cost ($189 X 12 months)		$752.76

Total Buy-Down Cost	($1,465.56 + $752.76)	$2,218.32

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

Who Pays for the Buydown?

Although the buyer has the option, the seller usually foots the bill. The cost of the home will adjust if the seller agrees to cover it.

You can also choose to use gift money. You can accept the cash as a gift if family or friends are willing to help you buy a home. You should review the procedure with your lender to receive and use the gift funds properly.

Can the Home Seller Pay the Buydown Cost?

A "seller-funded buydown" is when the seller of a property agrees to cover the buyer's down payment in exchange for a reduction in the sales price.

A purchase agreement specifying the total sales price and the down payment allows you to calculate what help the seller can give and how much money can be allocated towards your "buydown" expenses for a traditional mortgage when acquiring a property.

In most cases, the buydown may be covered by the full-price offer. The lender can assist in calculating the maximum sales reduction.

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

Borrowers must qualify for a 2-1 mortgage 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?

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.
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.

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 quickly. This type of mortgage is also a good option for those who may not qualify for a traditional mortgage.

SOURCE:
https://singlefamily.fanniemae.com/job-aid/loan-delivery/topic/overview_of_temp_buydown.htm
https://migonline.com/loan_officer/jackiegonzalez/page/rate-buy-down
https://www.trinityoaksmortgage.com/assets/uploads/2018/10/2-1-Buydown-Web-Flyer.pdf