In conclusion, 2-1 buydowns are a valuable tool in your real estate arsenal, especially in times of high-interest rates. They allow you to manage your payments strategically, and with the right negotiation tactics, you can leverage them to your advantage.
Borrowers can pay for a 2-1 buydown, but sellers, including home builders, also may offer a 2-1 buydown to make a property more attractive. These transactions can be a good deal for homebuyers if they can afford the higher monthly payments that will begin in year three.
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.
Requirements vary by lender, but you'll need to demonstrate a stronger financial profile to qualify for a 2/1 buydown mortgage. This typically means having a high credit score, good income, low debt-to-income (DTI) ratio, and the ability to make a larger down payment compared to traditional mortgages.
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.
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.
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.
If you're buying a home and have some extra cash to add to your down payment, you could consider buying down the rate. This would lower your payments going forward. This is a good strategy if the seller is willing to pay some of the closing costs.
The party funding the buydown, whether it is the seller, builder or buyer, kicks in enough money to reduce the buyer's mortgage rate by 2% the first year and 1% the second year as part of that party's closing costs. The mortgage carries the standard rate and payment in years 3-30.
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.
In an interest rate buydown, the seller pays mortgage points on the buyer's mortgage, lowering the interest rate. Permanent buydowns are more beneficial than price reductions for the buyer and the seller. Also called seller buydowns, they're better for buyers who plan on living in the same house for a long time.
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.
In a temporary buydown, the effective interest rate that a borrower pays during the early years of the mortgage is reduced as a result of the deposit of a lump sum of money (sometimes called a “subsidy”) into a buydown account, a portion of which is released each month to reduce the borrower's payments.
To afford a $600,000 house, you typically need to know how much income is required, which generally falls between $150,000 to $200,000 annually, depending on your financial situation, down payment, credit score, and current market conditions.
Experts often advise that you spend no more than approximately one-third of your income on housing costs. That means you can triple $64,800 to get a clearer picture of what the annual income requirements would be in order to comfortably afford a $900,000 home: approximately $194,400, at a bare minimum.
As noted above, your estimated monthly payment for a $500K mortgage will be $3,360.16, assuming a 30-year loan term and an interest rate of 7.1%. But this payment could range between $2,600 and $4,900 depending on your term and interest rate.
A mortgage point equals 1 percent of your total loan amount — for example, on a $100,000 loan, one point would be $1,000.
Here's another way to look at it. One mortgage discount point may reduce your interest rate by up to 0.25%. So, if your mortgage rate is 5%, one discount point would lower your rate to 4.75%, two points would lower the rate to 4.5%, and so on.
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.
The requirements for a 2-1 buydown vary between lenders, but typically require a higher credit score and/or a higher down payment in order to qualify for the lower 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.
The portion of the loan that isn't used to buy the house, also called “future advances,” is available to the borrower after the real estate transaction is complete. The unused portion of the mortgage can only be used to fund home improvements. Borrowers are not charged interest on the unused money until they access it.