Today’s mortgage rates are hovering right around the historic median of 7.5%. But after a decade of exceedingly low rates, the recent increases are causing some homebuyers to find creative ways to secure a lower rate.
Some buyers are paying mortgage points upfront to reduce their mortgage rates. Others are opting for an adjustable-rate mortgage (ARM) rather than fixing their rate for the term of the loan. And now, some buyers are seeking out a 2-1 buydown loan.
In this article, we’re going to explain what a 2-1 buydown loan is, how it works, and how it can help today’s homebuyers who are looking to save money on interest expenses.
What is a 2-1 Buydown Loan?
A 2-1 buydown loan is a type of mortgage financing in which the homebuyer pays a low introductory interest rate for the first year, a slightly higher rate during the second year, then the full interest rate from year three through the end of the loan term.
How Does a 2-1 Buydown Loan Work?
A 2-1 buydown is a special form of temporary buydown, which is when fees are paid upfront to “buy down” the interest rate for a portion of the loan term.
A buydown is generally used to incentivize buyers to purchase certain properties. For example, a home seller might agree to pay the upfront fees required to reduce the homebuyer’s mortgage interest rate for the first two years.
A 2-1 buydown loan is typically structured as follows:
Example of a 2-1 Buydown Loan
Let’s assume you’re borrowing $400,000 for a new home. The seller is offering a 2-1 buydown loan incentive, and your mortgage lender is offering a 30-year home loan at 7% interest.
The seller would pay fees upfront to offset the discount you would receive in interest expenses over the first two years of the mortgage.
In this case, you could save $9,323 in interest expenses over the first two years of your mortgage loan.
What are the Benefits of a 2-1 Buydown Loan for Homebuyers?
The benefit of a 2-1 buydown loan for homebuyers is the temporarily reduced interest expense. This can potentially make homeownership more accessible by allowing you to graduate from a lower rate to the full rate over time.
Because 2-1 buydowns reduce the cost of a mortgage for the first year, with a gradual increase in the second and third years, you may be able to purchase now and start building home equity immediately, rather than waiting a few more years to buy (at which point, home prices and interest rates could be higher than they are today).
What Should Buyers Watch for When Considering a 2-1 Buydown Loan?
If you are considering a 2-1 buydown loan, you should be sure you are comfortable with the full mortgage payment amount you will be making after the first two years.
You should also confirm that the purchase price is fair; some sellers may mark up the asking price to offset the cost of offering the 2-1 buydown. Your local real estate agent can help you determine the fair market value of the property to help you avoid overpaying for your new home.
Could a 2-1 Buydown Loan Work for You?
A 2-1 buydown loan could work for you if:
- You find a seller willing to offer this buydown, and
- You are confident that you will be able to comfortably cover the full-interest-rate mortgage payments that you will begin paying in year three of the loan
2-1 Buydown Loan FAQs
Does a 2-1 Buydown Loan Have Higher Upfront Fees?
Yes; buydown loans require upfront fees to offset the lender’s lost interest income from the discount to the interest rate in the first two years of the mortgage loan.
Who Pays the Buydown Fees?
In most cases, the buydown fees are paid by the home seller. This could be a private seller or an institutional seller (like a home builder, for example).
Are 2-1 Buydown Loans a Good Deal for Homebuyers?
They can be! As long as you can comfortably afford the mortgage payments with the full interest rates from year three on, you can benefit from reduced interest expenses in the first two years of your loan term.
Can You Refinance a 2-1 Buydown Loan?
Refinancing allows you to replace your existing home loan with a new home loan, under new terms. Refinancing is often used to secure a lower interest rate when market rates dip. It can also be used to cash out some of your home equity. You may be able to refinance your 2-1 buydown loan as long as the refinancing requirements relating to credit, income, equity, and payment history are met.
How Can Keller Home Loans Help?
Keller Home Loans has a team of knowledgeable and helpful mortgage professionals ready to help you make the most of your home purchase.
Start by contacting Keller Home Loans to discuss your mortgage options. We can help you choose the right type of home loan and secure favorable terms on your new loan. Then you can find a local real estate agent to help you analyze the current housing market, find your new home, and negotiate a good deal on your behalf.
Whether you use a 2-1 buydown loan or any of our other competitive mortgage financing options, the experts here at Keller Home Loans are excited to help you into your new home.