The borrower must qualify at the full note rate despite paying a discounted rate for the first two years. 2-1 buydown loans only apply to 30-year fixed rate mortgages. Credit, income, and further qualifications still apply and will vary by lender.
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.
To subsidize the borrower's reduced monthly payments, it typically costs a percentage of the total loan amount to reduce the interest rate. For example, on a $500,000 loan with a 6% contracted interest rate, the total cost of the buydown for the first and second year would be about 2.2% of the loan amount.
The borrower typically pays for a 2-1 buydown. However, some sellers may offer to pay for the buydown as a part of the purchase agreement.
This structure makes homeownership more affordable in the early years, especially for first-time homebuyers or those stretching their budget to buy a larger home. The upfront savings during the first two years can help cover other expenses like furniture, renovations, or moving costs.
One common question borrowers have is, “Can you refinance after a 2-1 buydown?” The answer is yes; refinancing is possible and can be a beneficial option for many borrowers.
The buydown interest percentage is the total of the interest for both years. That is, the buydown is 2% in the first year and 1% in the second year, for a total of 3%. The formula for calculating buydown points is: buydown points = (loan amount x percentage) / 100.
Consider the following example for a 30-year loan: On a $100,000 mortgage with an interest rate of 3%, your monthly payment for principal and interest would be $421 per month. If you purchase three discount points, your interest rate might be 2.25%, which puts your monthly payment at $382 per month.
Qualified borrowers could see a monthly mortgage payment of principal and interest between $3,043.80 and $4,029.80 for a $600,000 mortgage loan right now.
Buydown funds are not refundable unless the mortgage is paid off before all the funds have been applied. Buydown funds cannot be used to pay past-due payments. Buydown funds cannot be used to reduce the mortgage amount for purposes of determining the LTV ratio.
The 2-1 Buydown is ideal for those looking for short-term payment relief, while the Permanent Buydown offers long-term savings for those planning to stay in their homes for many years.
Rates could come down.
This is perhaps the biggest drawback of 2-1 buydown mortgages when you utilize them when interest rates are high. If rates come down, your locked rate could be much higher than the new current market rate, meaning an ARM would have been a better choice.
And here is even better news: The money for the temporary buydown goes into an escrow account and is applied to your loan every month during the buydown period. If you refinance or sell during that period, the unused portion gets applied to your home loan, reducing the balance of your loan.
The buydown funds may be provided by various parties, including the borrower, the lender, the borrower's employer, the property seller, or other interested parties to the transaction.
The borrower is required to pay 2 points on a $50,000 loan. A point is a fee equal to 1% of the loan amount. Therefore, 2 points on a $50,000 loan would be 2% of $50,000. Therefore, the borrower has to pay the lender $1,000 in points.
An amount paid to the lender, typically at closing, in order to lower the interest rate. Also known as “mortgage points” or “discount points.” One point equals 1% of the loan amount (for example, 2 points on a $100,000 mortgage would equal $2,000).
Generally, buying four mortgage points will lower your interest rate by 1 percent. That's also the maximum number of points most lenders will let you purchase. If you don't pay off your loan early, you'll eventually save more in interest than you spent upfront.
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.
For example, a 3-2-1 buydown Conventional 30 year fixed rate loan with a purchase price of $572,000, down payment of 20%, and an annual percentage rate of 7.178% would result in an interest rate of 4.125% (monthly payment of $2,772.20) for the first year, 5.125% (monthly payment of $3,114.47) for the second year, 6.125 ...
A 3-2-1 buydown mortgage defined
It gets its name from the variable rate of reduction during those first three years: 3% for the first year of financing, 2% for the second, and 1% for the third (and final) year of reduced-rate payments. From the fourth year onwards, you'll pay the full interest rate.
Buydown Costs = Unpaid Interest
The cost of the 2-1 buydown is the sum of the unpaid interest for the first two years. Over the first two years, Joe has “saved” $9,323.18 ($6,167 + $3,156) of interest. This amount is the total amount the seller has a requirement to pay at closing to secure the 2-1 buydown.
How many points can you buy down the interest rate? There is no set limit for how many mortgage points you can purchase, but most lenders limit borrowers to four points. Due to state and federal limitations, there are restrictions on the amount a borrower can pay in closing costs on a mortgage.
The Quick Answer
Typically, you can expect to pay between 0.25% to 1% of your total loan amount for every 0.25% you want to shave off your interest rate. For example, if you have a $200,000 loan and want to reduce your interest rate by 0.25%, it could cost you anywhere from $500 to $2,000.