Home Loans

Using the 2 - 1 Buydown

The 2-1 buydown is a real estate financing technique…an attractive home loan provision whereby funds are set aside in an escrow account at the closing, for the benefit of the buyer. These escrowed buydown funds permit the home buyer to “buy down” the interest rate on their home loan…as the buyer's interest rate is “bought down” for the two-year period.

With the 2-1 buydown, in year one, the home buyer’s interest rate will be 2 percent below their 30-year rate. In year two, the home buyer’s interest rate will be 1 percent below their 30-year rate. The 2-1 buydown is very simple - it’s a 2 percent interest rate reduction for the buyer during the first year of their home loan, and it is a 1 percent interest rate reduction for the home buyer during the second year of their home loan.

For the home buyer, in years three through thirty, their home loan will have the same fixed interest rate (and the same fixed payment) throughout the loan period. The buyer's interest rate (and the buyer's monthly payment) is set at the fixed rate the buyer locks into when they close on their home loan. That interest rate is 2 percent above what the home buyer’s interest rate will be in year one when using the 2-1 buydown, and 1 percent above what the home buyer's interest rate will be in year two when using the 2-1 buydown.

For home buyers, the 2-1 buydown has benefits. One such benefit is, that the 2-1 buydown provides the home buyer with the opportunity to qualify for a home mortgage with a larger loan balance when they purchase their home at the outset. While at the same time, also enabling the home buyer to potentially purchase a larger home. Or a home with more features. In summary, a home buyer can purchase a larger home, a home buyer can purchase a more expensive home, and/or a home buyer can purchase a home with more "bells and whistles"...each benefit is made possible for the home buyer through the wise use of the 2-1 buydown provision.

What Does a 2-1 Buydown Cost?

The cost of the 2-1 buydown is equal to the difference between the principal and interest payments of the 30-year note rate for the home loan, and the principal and interest payments for the buydown rates established for the home buyer in year one and year two through the 2-1 buydown. The escrowed buydown funds are paid at closing by the seller and held in an escrow account for the buyer.

When are 2-1 Buydowns Used?

When a real estate market is softening. When more home sellers are putting their homes on the market (i.e.: increased inventory). When a higher percentage of homes listed for sale are incurring price reductions. When homes are sitting on the market - unsold - for longer periods of time. Each market circumstance referred to, potentially being a good time for a home seller to consider implementing the 2-1 buydown strategy to sell their home (at their desired sale price) by providing this attractive 2-1 buydown option to buyers. Thus, attracting more buyers to their home.

Furthermore, when a real estate market shifts from a seller’s market to a buyer’s market, the 2-1 buydown could be a very smart benefit provided to prospective home buyers by sellers.

With the 2-1 buydown, the seller covers the buydown cost for the buyer. The seller provides this benefit, in exchange for the related benefit the seller can realize by selling their home at the (higher) desired sale price. Done so, through the use of the 2-1 buydown, by crediting the buyer with the buydown fees at the closing.

Interest rates have increased substantially since the beginning of the year. In an increasing interest rate environment (like today) home buyers are now considering purchasing a home using a mortgage which has a higher interest rate. With that higher interest rate, the buyer now attains, will come higher monthly payments. The 2-1 buydown can help to mitigate this “financial shock” for home buyers, while at the same time, providing more home buyers with an opportunity to get into more homes today at an interest rate (during the first two years of the loan) which is closer to the early-year interest rates home buyers were more acclimated to seeing.

It goes without saying that interest rates today are notably higher than they had been, early on in 2022. This means families looking to buy a home today are taking notice of these higher interest rates. Higher interest rates affect family budgets. Which in turn, affects offers buyers make. Which in turn, then affects the prices sellers attain by selling their homes. Hence, sound reasoning for the use of the 2-1 buydown. The 2-1 benefits buyers, and the 2-1 buydown benefits sellers as well.

All said, using the 2-1 buydown provision in an increasing interest rate environment (I.e.: today) can position the home a seller is intent on selling in the marketplace as a more attractive option to more prospective home buyers…as compared to comparable homes which are on the market that the buyer might consider purchasing which do not come with the attractive 2-1 buydown provision. I.e.: homes that do not offer the buyer an opportunity to get into more homes now, with a lower monthly mortgage payment (now, as well).

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