Demystifying the 2/1 Mortgage Rate Buydown: A Simple Explanation

A 2/1 buydown is a type of financing that lowers the interest rate on a mortgage for the first two years before it rises to the regular, permanent rate. The rate is typically two percentage points lower during the first year and one percentage point lower in the second year. Since the summer of 2022, the 2/1 buydown loan option has skyrocketed in popularity and has become one of the best ways to combat the historically fast-rising intererst rates. Stay tuned to our blog for additional resources on this topic.

How 2/1 Buydowns Work 

A buydown is a real estate financing technique that makes it easier for a borrower to qualify for a mortgage with a lower interest rate. That lower rate can last for the duration of the mortgage (as is often the case when borrowers pay extra points up front to the lender) or for a particular period of time. A 2/1 buydown is one kind of temporary buydown, in this case lasting for two years.

In a 2/1 buydown, the interest rate will increase from one year to the next until it settles into its permanent rate in year three. To make up for the interest that they won’t be receiving in those early years, lenders will charge an additional fee.

Key Takeaways:

• A 2/1 buydown is a type of financing that lowers the interest rate on a mortgage for the first two years before it rises to the regular, permanent rate.
• The rate is typically two percentage points lower during the first year and one percentage point lower in the second year.
• Sellers, including home builders, may offer a 2/1 buydown to make a property more attractive to buyers.
• 2/1 buydowns can be a good deal for homebuyers, provided that they will be able to afford the higher monthly payments once those begin. 

2/1 Buydown Pros and Cons 

For home sellers, a 2/1 buydown can help them by making it easier and sometimes faster for them to sell their homes for a good price. The downside, of course, is that it comes at a cost, which ultimately reduces how much they will net from the sale.

For homebuyers, a 2/1 buydown has several potential benefits. For one thing, it can help them afford a larger mortgage and a more expensive home than they might otherwise qualify for. For another, it buys them some time before their mortgage payments rise to the full amount, which can be helpful if their income is also rising from year to year.

The downside for homebuyers is the risk that their income won’t keep pace with those increasing mortgage payments. In that case, they might find themselves stretched too thin and even have to sell the home.

When to Use a 2/1 Buydown 

Home sellers may want to consider offering (and paying for) a 2/1 buydown if they’re having difficulty selling and need to provide an incentive to find a buyer.

Borrowers may benefit from a buydown if it allows them to buy the home they want at a price they can afford. However, they will also want to consider what would happen if their income doesn’t rise fast enough to keep up with their future monthly payments.

Buyers should also make sure that they are getting a fair deal on the home in the first place. That’s because some sellers might increase the home’s price to make up for the cost of the 2/1 buydown.

Note that buydowns may not be available under some state and federal mortgage programs or from all lenders. A 2/1 buydown is available on fixed-rate Federal Housing Administration (FHA) loans, but only for new mortgages and not for refinancing. Terms can also vary from lender to lender.

Can I refinance out of a 2/1 buydown?

Refinancing your 2/1 buydown mortgage can come with a range of costs, such as closing costs, appraisal fees and application fees. Before refinancing, consider these costs and ensure that the potential savings outweigh the costs

Are you considering buying a home but feeling overwhelmed by the various mortgage options available? Don't worry, you're not alone! One option you might come across is a "2/1 mortgage rate buydown." It might sound complex at first, but fear not! Let's break down this concept into simple terms.

Imagine you're getting ready to buy your dream home, and you're looking for the best mortgage deal. A 2/1 mortgage rate buydown is like a financial tool that can help you ease into your mortgage payments for the first few years.

Here's how it works:

1. The Introductory Period (First Year):

During the initial phase of the mortgage (the first 2 years), you'll enjoy a lower interest rate than what you would typically have on a regular mortgage. This lower rate is often referred to as the "buydown rate." It's like getting a special discount on your mortgage interest! The first year you'll enjoy the equivalent of having a mortgage rate 2 percentage points below your actual rate. 

1. Gradual Adjustment (Year 2):

Once the initial year is up, your interest rate will start to increase. But fear not! It won't jump to the "regular" rate right away. You'll enjoy the equivalent of a 1% reduction in mortgage rate.

1. Stable Phase (Years 3 and Beyond):

After the second year, your interest rate will stay fixed at the higher, fully indexed rate. This rate will remain constant for the rest of your mortgage term unless you refinance.

Putting It All Together with an Example

Let's say you're getting a 30-year fixed-rate mortgage with a 2/1 buydown. If the regular interest rate is 7%, during the first 2 years, you might have a rate of 5%, then 6% in the second year. It’s not until the third year that your rate would increase by 2 percentage points to 7%. This 7% rate would then remain steady for the remaining years of your mortgage unless/until you refinance or sell, of course.

The benefit of a 2/1 mortgage rate buydown is to make your initial years of homeownership more affordable. It can be especially helpful if you're tight on your budget during those early years but expect your income to increase in the future.

Remember, the specifics of a mortgage rate buydown can vary, so it's important to work closely with your lender to understand all the details and make sure it's the right fit for your financial situation.

Bottom Line

In essence, a 2/1 mortgage rate buydown is like a friendly financial arrangement that helps you ease into your mortgage payments, giving you some breathing room at the beginning and gradually adjusting as you settle into your new home. It's all about finding a mortgage that fits your unique needs and making your homeownership journey a smoother ride. For more informaion on how we're helping our clients utilize the 2/1 buydown to make homebuying more affordable, reach out. We would also be happy to introduce you to our preferred lending partners who understand and work with such lending options on a daily basis, with extraordinary results.