You’ve probably been hearing the phrase “2-1 buydown” being thrown around a lot lately. But what really is a 2-1 Buydown?

A 2-1 buydown loan lets you temporarily lower your interest during the first couple of years of homeownership in exchange for an upfront additional charge. During the first year of homeownership, you’ll pay an interest rate that’s 2% lower than your standard rate. In the second year, your interest rate will be 1% lower than the agreed-upon rate. Once the first two years are up, you’ll begin paying the permanent interest rate on your mortgage.

In exchange for a lower rate, the difference is paid through a one-time fee when you close on your home. This fee is deposited in an escrow account, and a small amount is paid out every month to cover the difference. Through this process, you are essentially buying your way into obtaining a lower interest rate for a two-year period.

How a 2-1 Buydown Works

With a 2-1 buydown loan, the borrower pays a lump sum upfront, ensuring a temporarily lower interest rate for the first two years.

To help you better understand a 2-1 buydown, let’s look at an example of how one would play out. Let’s say you’re purchasing a $500,000 home using a Conventional loan at 10% down with a 6.5% fixed interest rate. If you agree upon a 2-1 buydown, you’ll pay 4.5% in interest for the first year of homeownership. During that year, your monthly principal & interest payment would be $2,280.08.

After that year is up, your interest rate will go up to 5.5% and your monthly principal & interest payments will go up slightly to $2,555.05. After the two years are up, you’ll begin paying your permanent rate of 6.5% and your monthly payments will stay at $2,844.31.

This arrangement allows you to save money on your monthly mortgage payments during those two years. During the first year of your 2-1 buydown, you’ll save $564.23 per month and during the second year, you’ll save $289.26 per month. The difference of $10,241.88 must be paid upfront and deposited into an escrow account.

During the homebuying process, you can negotiate to get the seller or builder to fund the fee associated with a 2-1 buydown. Your real estate agent can help you negotiate this during the offer stage.

Qualifying for a 2-1 Buydown

When applying for a mortgage with the 2-1 buydown, the buyer will need to qualify using the full payment based on the actual interest rate, not the temporarily reduced rate.

The temporarily lower payments for the first two years doesn’t make mortgage underwriting easier. The borrower must use their qualifying income, credit, and assets to receive approval on the potential full payment.

These are not “risky” loans like those from the past because the buyer must be able to qualify for the full payment before ever closing on the loan. Furthermore, the buyer knows exactly what the future payments will be before closing on the loan.

Other Buydown Options

1-0 Buydown

With a 1-0 buydown, you’ll pay an interest rate that’s 1% lower than the agreed-upon rate during your first year of homeownership. For example, if your regular interest rate is 5%, it’ll be 4% for the first year. You won’t lower your mortgage payments as much as you would with a 2-1 buydown, but you’ll also have to pay less money upfront.

3-2-1 Buydown

In a 3-2-1 buydown, your interest rate will be 3% lower the first year, 2% lower the second year, and 1% lower the third year before adjusting to your fixed rate. This is a great way to lower your monthly mortgage payments, but the initial escrow payment will be higher than a 2-1 buydown.

Sources

1. New American Funding. “Buydown Loan.” Accessed November 28, 2022.
2. The Balance Money. “What is a 2-1 Buydown”. Accessed November 28, 2022
3. Mortgagemark.com. “2-1-buydown.” Accessed November 28, 2022