What is a 2-1 Temporary Rate Buydown,
…and is it worth it?
As mortgage rates hit 6.25% and above, home buyers are increasingly interested in options that can help reduce their initial mortgage payments. The belief here is that rates will decline enough in the near future so that a refinance to a lower permanent rate makes sense.
The most popular way to temporarily reduce the current market rate is by using what’s called a “Temporary Buydown Mortgage”.
A Temporary Buydown Mortgage provides for a reduced market rate during the first few years of the loan. There are currently three buydown mortgage options available today – The 1-1, 2-1, and 3-2-1 buydown mortgage, with the 2-1 buydown being the most popular.
By selecting a 2-1 buydown mortgage, the lender will reduce the loan rate by 2% the first year, 1% the second year, and in years 3-30 the rate will be at the full note rate.
For example, if the market rate is 6.25%, the interest rate and monthly payment will be based on a rate of 4.25% the first year, 5.25% in year two. and 6.25% for the remainder of the term.
Who pays for this benefit?
There is, of course, a cost for the benefit of a reduced rate. Here are four of the most common ways to cover that cost:
- Seller Concession – Using a seller concession, the seller would cover the cost of the buydown by providing a credit at closing. Typically, that credit is built into the sales price. In a higher rate environment, many sellers are willing to provide this credit if having a lower mortgage rate makes the payment more attractive and in turn helps their home sell faster.
- Lender Credit – here the lender provides a lender credit at closing to cover the cost of the buydown. This is done by increasing the base market rate in later years. For example, if the market rate is currently 6.25%, a 2/1 lender paid buydown might be 4.75% in year one, 5.75% in year two, and 6.75% in years 3-30. In this example, the increase from the current market rate of 6.25% to 6.75% allows the lender to cover some or all the cost to bring the rate down in years 1 & 2.
- Lender/Seller Credit – the most common way to cover the buy-down cost is by combining a Lender & Seller credit as mentioned above.
- Borrower Paid – Here the borrower would put up the cost for the buydown at closing. This is the least common way since many homebuyers are stretching to cover the down payment and traditional closing costs.
What are the pros and cons?
From a seller’s perspective, the 2-1 buydown can sometimes make it easier and faster to sell their home since the reduction in payment makes their home more attractive to potential buyers. Home builders have been using interest rate buydowns for years to help sell new construction homes.
For homebuyers, there are a few potential benefits to a 2-1 buydown. Because a temporary buydown decreases their mortgage payment for the first two years, the borrower can have more money available to them during that period than they would if they were paying the full mortgage payment. That money can be used to increase savings, pay down other debt, or to help make minor home improvements.
A 2-1 buydown can also ease new homeowners into the process of paying a monthly mortgage by starting them at a lower payment. If a buyer expects their income to rise over the next two years, or if they anticipate refinancing to a lower rate down the road, a 2-1 buydown is worth consideration.
The downside is that a 2-1 buydown does come with upfront cost and is typically only worth it for the buyer if they can get the buydown cost covered via a seller concession, lender credit, or a combination of both.
This article was provided by Joe Farella, industry expert and author of the award-winning book, “Insider Secrets to Home Buying Success”. Mr. Farella is also the Executive Vice President of American United Mortgage Corporation, Scotch Plains, NJ. For questions about your New Jersey home purchase, feel free to call Joe at 908.322.5423 or via email: firstname.lastname@example.org