What is a 2-1 buydown?

With mortgage interest rates continuing to hover in the 7% range, borrowers are looking for ways to make purchasing a home more affordable.  One solution that some lenders offer is called a 2-1 buydown. A 2-1 buydown is a mortgage agreement between the lender and borrower that provides a lower mortgage rate than is currently offered for the first year of the loan, then a somewhat higher rate the second year, and then the full rate for the third year and beyond.

Typically, the rate is two percentage points lower for the first year and one percentage point lower for the second year. A 2-1 buydown can either be paid by the borrower or the homeowner as a seller concession. Home builders and real estate developers commonly use 2-1 buydowns to incentivize purchasing.

How does a 2-1 buydown work?

The “2” in a 2-1 buydown means that the interest rate is lowered for the first two years of the loan, incrementally increasing from the first year to the second year and ending up at the permanent rate. To compensate for the interest that won’t be collected those first two years, lenders will charge an additional fee in the form of a lump sum deposited in an escrow account or collect mortgage points.

What are the pros and cons of a 2-1 buydown?

While a 2-1 buydown can have some clear benefits for the buyer, there are also a few downsides. Here are a few pros:

• Smaller mortgage payments for the first two years of your loan
• Less interest is paid over the life of the loan
• It takes into account making more salary over the time the rate rises
• It makes it easier to afford a more expensive home
• You may be able to write off the buydown on income taxes*
• Saved money on mortgage payments can be used to renovate or furnish a new home

Here are some cons to consider before getting a 2-1 buydown:

• If you are paying the buydown, you may need to dig deep into savings.
• Closing costs may be higher to offset the lower mortgage interest rate
• It may be problematic if income doesn’t grow with the rate increase

A 2-1 buydown may be the best solution to get a home loan with lower mortgage rates, especially if the seller pays for the buydown. If you think a 2-1 buydown may suit your situation, call the experts at NASB at 888-661-1982. 

*This blog is not intended to and does not constitute legal or financial / investment/tax advice. North American Savings Bank does not guarantee or promise the results obtained. The consumer should consult a tax adviser for further information regarding the deductibility of interest and charges.