How Does a 2-1 Buydown Mortgage Work?
The way a 2-1 buydown works is that the seller will pay the lender a fixed fee in exchange for a temporarily lower interest rate. The seller typically offers a 2-1 buydown to make the home more attractive to potential buyers. The fee is paid to the lender to buy down the interest rate, resulting in a lower monthly mortgage payment for the borrower.
2-1 Buydown Example
Let's say you are considering getting a $250,000 30-year fixed-rate mortgage with an interest rate of 5.5%. A typical 2-1 buydown fee for this mortgage loan would be around $7,500. If you decide to buydown the interest rate, it will be reduced to 3.5% for the first year of the loan and then increases to 4.5% in the second year before reaching the full 5.5% rate in the third year and remaining at that level for the remainder of the loan term.
In the first two years of the loan, your monthly mortgage payment would be based on the lower interest rates of 3.5% and 4.5%. For example, on a mortgage of $250,000 with a 3.5% interest rate, your monthly payment would be around $1,050. With a 4.5% interest rate, your monthly mortgage payment would be approximately $1,125. In the third year and beyond, your monthly mortgage payment would be based on the full interest rate of 5.5%, resulting in a payment of around $1,225 per month.
This example illustrates how a 2-1 buydown mortgage can result in lower monthly mortgage payments in the short term but higher payments in the long run. It's essential to carefully consider the long-term costs and benefits of this type of financing before deciding whether it is right for you.
2-1 Buydown Pros and Cons
2-1 Buydown Pros
1. Lower Monthly Mortgage Payments in the Short Term
The upfront fee that is paid to buy down the interest rate on the mortgage results in lower monthly mortgage payments in the first two years of the loan, which can be helpful if a buyer has a lower income or is trying to qualify for a mortgage with a lower debt-to-income ratio.
2. Can Help Sell a Home Faster
One of the best reasons for a seller to offer a 2-1 buydown is that it can help sell the home faster. It saves the buyer money and will lighten the payment burden associated with the house for the first two years.
3. Great For Buyers Whose Income Will Rise
2-1 buydown mortgages can be a good option for buyers who expect their income to increase significantly throughout the loan, as the lower payments in the early years can be more affordable.
2-1 Buydown Cons
1. Higher Interest and Payments in the Long Run
One of the main drawbacks of a 2-1 buydown is that the monthly payments rise after the first two years. The higher interest rates in the later years will result in higher monthly payments.
2. Additional Upfront Fee
You will need to pay an additional upfront fee for a 2-1 buydown mortgage. And the fee you pay to buy down the interest rate on your mortgage can be substantial. This will increase closing costs and is one of the main reasons why paying for a 2-1 buydown doesn't make sense for many buyers.
3. Difficulty in predicting future income
If a buyer is relying on future income increases to make the higher monthly mortgage payments after the buydown period ends, they are taking on more risk. It's possible their income will not increase as expected.
4. Limited Availability
2-1 buydown mortgages are only available from some lenders, so you may have a limited selection of lenders to choose from.
Is a 2-1 Buydown a Good Idea?
A 2-1 buydown mortgage can be an excellent option for a buyer if the seller is covering the buydown costs. However, it's important to carefully consider the potential pros and weigh them against the potential drawbacks of a 2-1 buydown mortgage before deciding whether this type of financing is right for you. You may also want to consult with a financial advisor or a mortgage professional to help you make an informed decision.