What is a 2-1 Buydown Mortgage? Exploring the Pros and Cons
What is a 2-1 Buydown? Is it the right kind of mortgage for you? This type of home financing offers prospective borrowers a low interest rate for the first year of the loan. The rate goes a little higher in the second year and reaches its full amount by the third year. The third-year rate will be the one that borrowers pay for the rest of the loan term.
For some, this type of tiered pricing is the best way to achieve the funding they need. For others, there might be better options that allow them to save more money while paying off their home.
Today, we’re sharing all the details about this process, so you can decide if could work for you.
How Does a 2-1 Buydown Mortgage Work?
Naturally, borrowers can qualify more easily for loans when the interest rate is low. Buydowns are a special type of real estate financing that make this option more accessible for qualified applicants.
While the lowest rate often lasts just one year, you can make some buydowns last for the full duration of your mortgage. To do so, you’ll need to pay extra “points” upfront to your lender. Or, you can pay those points to your lender over a designated period of time.
A 2-1 buydown is one type of buydown mortgage. With this type of loan, your rate is reduced for the first two years, with the lowest price applied in Year 1. The rate will gradually increase from one year to the next, reaching its full, permanent rate in Year 3.
The only caveat? Lenders aren’t lowering the interest rate for your benefit only. They must find a way to make up for the money they’re essentially losing over those first two years, and they’ll do so by charging borrowers an extra fee.
A homebuyer or a home seller can purchase a buydown. Sellers and builders will often cover the cost and use this tactic to attract prospective buyers. There are two options:
- Purchasing the buydown via mortgage points
- Purchasing the buydown as a lump sum, put in an escrow account with the lender
If buyers choose the lump sum option, their payments will be used to subsidize their reduced monthly payments.
Real-Life Example
This type of home financing can get a little complicated. It helps to have a real-life example to explain the steps.
Let’s say that a real estate developer is offering a 2-1 buydown as an incentive for a new neighborhood he’s building. If the current, prevailing interest rate is 7%, they would pay 5% in Year 1, 6% in Year 2, and the full 7% in Year 3.
When Should You Consider a 2-1 Buydown?
There are a few situations in which a 2-1 buydown can be a viable way forward. Let’s review some common examples.
Your Home Isn’t Selling
Are you having difficulty selling your home? If you’re not getting the interest you expected, you might want to consider offering (and funding) a 2-1 buydown. This incentive can draw additional buzz around your listing and could bring the right buyers to your doorstep.
If you’re a buyer who’s interested in a home that’s been listed for a while, you can ask your real estate agent to inquire about a 2-1 buydown. In some cases, the sellers might be interested in going that route if it means moving the process along at a faster pace.
A real estate agent can also talk to you about all of the other ways you can finance your home, so you’re aware of all of your options!
You’re Eyeing a Larger Home
A 2-1 buydown can help you purchase a larger property at a rate that can ease you into a larger payment. However, don’t get starstruck by that Year 1 rate. Understand that this rate won’t last forever, and by Year 2 it will be higher.
You should be confident that your income will rise at the same pace that the payments do. Or, it should already be high enough to cover Year 3 payments and beyond.
Before you take advantage of a 2-1 buydown offer from a seller, take the time to research the home’s listing price. In some instances, sellers will increase their asking price to help them absorb the cost of the buydown. When this is the case, you could wind up paying too much for the property, even if the financing terms were attractive at first.
What Are the Pros of a 2-1 Buydown?
Are you thinking about pursuing a 2-1 buydown? If so, here are the top benefits you need to know.
It Can Help You Sell Your Home
If you’re selling your home, offering a 2-1 buydown on the mortgage can help attract prospective buyers. This is because this type of mortgage is more affordable to buyers, at least in the beginning.
This can be a helpful option if the current selling conditions aren’t working in your favor, and your home has sat on the market for an extended period of time.
It Can Help You Afford a Larger Mortgage
Eyeing a bigger home but know you can’t afford the full mortgage? If so, a 2-1 buydown can work in your favor. These loans allow you to qualify for a larger mortgage and a more expensive home than you could achieve with a conventional loan.
As long as the full-rate payments are manageable, you could use the buydown to get into your dream home quicker.
It Helps You Save in the First Years
Do you anticipate that your income will rise from one year to the next? If so, look into a 2-1 buydown. The financing structure will help you bide your time and allow you to save as much as possible before your mortgage payments reach their full amount.
Keep in mind, though, that you should be fully confident in this income increase before using it as a reason to pursue a buydown.
It Gets You Accustomed to Homeownership
For those first 12 months, your monthly payment will be significantly lower. This can help you ease into making regular payments, and allows you to save as much as possible throughout the initial term.
Especially for first-time homebuyers, this can be a good way to slowly grow accustomed to the process of setting aside enough money for your mortgage each month. If you’ve never had to make these kinds of payments before, it can be difficult to balance your budget. With a 2-1 buydown, it can be easier to learn the system.
What Are the Cons of a 2-1 Buydown?
While a 2-1 buydown can help you finance your home, it can also work against you in some cases. Next, let’s take a look at a few of the top drawbacks to consider.
You Could Lose Money as a Seller
If you’re selling your home and you decide to offer this option, keep in mind that it will lower the overall amount that you will earn from the sale of your property because you are giving “seller concessions” to the would-be buyer. However, if you’re willing to take that reduction to hopefully sell your home quicker and more easily, it can be a smart choice.
You Could Struggle to Pay the Higher Rates
A 2-1 buydown isn’t the best option if you’re worried that your income won’t increase along with the payments. While Year 1 might be manageable, you could find yourself struggling to keep up with the Year 2 and Year 3 payments. If that happens, you could be forced to sell the home. Keep in mind, mortgage companies are required to run your qualification numbers based on the final interest rate, not jus that of the initial few years.
They Aren’t Always Available
While 2-1 buydowns are common, they are not allowed under every type of mortgage program. In addition, not all lenders will offer them, and the terms can differ from one lender to the next.
For example, you can pursue a 2-1 buydown on a fixed-rate Federal Housing Administration (FHA) loan. However, this option is only limited to new FHA mortgages and does not apply to refinancing loans. Make sure you understand the availability of this option and how all of the terms work before making a decision.
There’s an Up-Front Cost
Typically, a 2-1 buydown is only worth it if you can convince the seller to cover the costs of the escrow deposit. If this isn’t an option, the initial fee can be substantial and could offset any potential savings you make from this setup.
Review Your Mortgage Options Today
Are you ready to put down roots? If so, it’s time to start thinking about the type of mortgage you’ll need.
A 2-1 buydown mortgage can be a great option, but it’s far from your only option. This is one of the biggest investments you’ll ever make, so it’s important to understand all of your choices.
If you’re interested in living in New Homes in Raleigh, NC, reach out to us today! We can help you find the perfect floor plan and community, or you can shop all of our available homes online!
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