Hi everyone! Today, I want to talk about a trend that’s been gaining a lot of traction with homebuyers — the 2-1 buydown. If you’re scratching your head, wondering what that is, you’re in the right place.
So, what exactly is a 2-1 buydown? Well, it’s a strategy employed by mortgage lenders to offer borrowers a temporary reduction in their interest rates. Typically, with a 2-1 buydown, the interest rate is two percentage points lower in the first year and one percentage point lower in the second year.
Let’s look at an example to help you understand what it looks like in action.
Let’s say you’re buying a $450,000 house with a 20% down payment for a mortgage loan of $360,000, an interest rate of 7% and an APR of 7.094%. A monthly principal and interest payment would be about $2,395.05.
With a 2-1 buydown, your interest rate would decrease by 2% from the original rate for the first year. So, with a 5% interest rate, your monthly P&I amount would be $1,932.56.
The following year, your interest rate would go down by one percentage point from the original rate, taking it to 6%. The monthly P&I amount you’d be paying would be $2,158.38.
From the third year onwards, your payment would then be at the original 7% interest rate, taking your monthly P&I back to $2,395.05.
Bear in mind that this scenario doesn’t factor in taxes and insurance, so your actual monthly payment amount might vary, but you can see the difference between years 1 and 2 versus year 3 and after. Running these different scenarios can help you better forecast what you’ll be paying for the first two years versus the third year onwards to understand if it’s the right decision for you.
You are probably wondering who pays for the buy down and what are the costs, and the answer is….it depends. Right now, we are seeing sellers offer a 2-1 buydown as an incentive to attract buyers when they’re keen to sell quickly. The seller will pay the upfront cost to temporarily reduce the buyer’s mortgage interest rate for the first two years.
Sometimes, buyers opt to pay for the buydown themselves to reduce their initial mortgage payments. This can be a strategic choice if they expect their income to increase over the next few years.
In some cases, a third party like a home builder (in the case of new construction homes) or a family member may pay for the buydown as part of a promotional deal or as a gift.
The choice of who pays for the buydown is often a point of negotiation and can vary based on the specifics of the real estate transaction and the motivations of the involved parties.
Now let’s break down the pros and cons.
The most obvious benefit is that it provides immediate relief on your monthly mortgage payments during the initial years of homeownership. This can be particularly helpful if you’re stretching your budget to buy your dream home because the lower initial payments can give you some breathing room as you settle into your new space. Plus, it can be an appealing option if you anticipate an increase in your income in the coming years.
Now, let’s consider the other side of the coin. While the 2-1 buydown offers short-term relief, it’s essential to understand that your payments WILL increase after the initial two years when the interest rates return to their original levels. This means you need to be financially prepared for higher monthly payments down the road. It’s also crucial to carefully review the terms and conditions of the buydown, as there may be specific restrictions and fees associated with this arrangement.
For those considering a 2-1 buydown, here are a few tips. First, crunch the numbers and make sure you can comfortably afford the higher payments that will kick in after the initial period. Second, carefully read the fine print of the mortgage agreement to understand any fees or restrictions tied to the buydown. And finally, consult with a financial advisor or mortgage lender to ensure that a 2-1 buydown aligns with your long-term financial goals.
In summary, the 2-1 buydown is a tool that can offer short-term financial relief for homebuyers, but like any financial decision, it requires careful consideration.