Today’s interest rates are extraordinarily high compared to what most borrowers have seen in the last couple of years. So if the higher rates are pricing you out of the market or you wonder if now’s the right time to buy a home, you might consider a 2-1 buydown.
This temporary rate buydown makes your mortgage payment more affordable and then adjusts to its ‘normal’ rate at the end of the temporary period.
Here’s what you should know when deciding if the 2-1 buydown is right for you.
Understanding the 2-1 Buydown
As the name suggests, the 2-1 buydown offers a way to buy down your rate, but it’s temporary. During the first two years, you’ll pay a lower interest rate. Then, in the third year, the rate goes up to the standard rate you would have received on a fixed-rate mortgage.
To get the 2-1 buydown, you’ll pay an upfront fee to make up the difference in what lenders aren’t receiving with the lower interest rate. However, if you’re buying a home and find a motivated seller, you may be able to negotiate the cost of the buydown into the terms, asking the seller to pay it.
How Does it Work?
The premise of the 2-1 buydown is simple. First, it temporarily lowers your interest rate.
You’ll pay a rate of 2% lower than the standard in the first year. Then, on the anniversary of your first payment, the rate adjusts to 1% lower than the standard rate.
You’ll be back to paying the standard rate at the start of the third year of payments. This is your permanent interest rate – the rate you’ll pay as long as you have the loan.
To get this option, you’ll pay points at the closing, which increases your closing costs but decreases your monthly payments.
Example of a 2-1 Buydown
If you borrow a $200,000 mortgage at 6%, your principal and interest payment would be $1,199.10 monthly.
However, if you paid for a 2-1 buydown, you’d pay 4% interest for the first year, which brings your payments down to $954.83 a month. This is a savings of $244.77 a month.
In the second year, your interest rate would be 5%, and your monthly payment would be $1,073.64.
Starting the third year, your payment would increase to $1,119.10. This would be your payment for the remaining 27 years of the term too.
Pros and Cons of the 2-1 Buydown
Like any mortgage, the 2-1 buydown has pros and cons, including the following.
Pros:
- It’s easier to afford your payments for the first two years. If you are in a position where your income will increase in a couple of years, you can afford to buy a house now and know you’ll be able to afford the higher payments in the future.
- You’ll have less payment shock. If you’re a first-time homebuyer, easing into your mortgage payments can result in less payment shock. In other words, the difference between your rent payment to mortgage payment won’t be as extreme.
- You can invest the money you save in the first two years. If you can afford the full payment in the first couple of years, take the difference in the payment and invest it. This can help you save for other financial goals.
Cons:
- The buydown is temporary. If your income wasn’t what you expected in two years, you might not be able to afford the higher payment.
- You’ll pay higher closing costs. To get a buydown, you must pay points at the closing, which increases how much you need to close on the home.
Is a 2-1 Buydown Better than Buying the Rate Down Forever?
The difference between buying the rate down temporarily and permanently is the cost. It costs more to buy it down permanently.
So how do you decide?
Think about the home in terms of investment. How long do you plan to own it? If you’ll move in a few years, paying for a permanently lower rate doesn’t make sense. However, if this is your ‘forever home,’ it may be worth paying the higher costs and buying the rate down forever.
Final Thoughts
A 2-1 buydown can help make your rate more affordable temporarily. However, it only lasts for two years, and in the third year, the rate goes back to its standard. If you want to make homeownership more affordable right now, the 2-1 buydown may be the way to go.
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