Interest rates are expected to remain volatile this year as the Federal Reserve continues its efforts to tame inflation.
To help more borrowers afford a home in today’s market, loan officers have brought back the 2-1 buydown loan option.
What's in this article?
A 2-1 buydown lowers a borrower’s interest rate in the first two years of homeownership, which can potentially help them save thousands of dollars.
Compass Mortgage offers a 2-1 buydown option for our borrowers. In our complete guide to 2-1 buydown loans, we will answer all of your questions about how it works, what is required and how you can get one.
Let’s dig in.
What is a mortgage buydown?
A buydown is a financing method where a borrower receives a lower interest rate in the first few years of their loan in exchange for an up-front payment.
After the first few years are up, the rate that was agreed upon at closing becomes effective for the remainder of the term of the loan.
A mortgage buydown is not a new product, but it hasn’t been widely used since the late 1970s and early 1980s when interest rates reached as high as 18%.
Buydowns were last used as a result of that financial crisis years ago, but they were controversial at the time because some lenders were not ensuring the borrower could afford the post-buydown rate.
As a result, when the buydown period ended, borrowers often were unable to make the expected monthly payments.
Since then, rules have been put in place to protect borrowers. Borrowers now must qualify for the highest interest rate, rather than the initial reduced rates.
The most common buydown option today is the 2-1 buydown. In the first year of a 2-1 buydown, the borrower has a 2% reduced interest rate. In the second year, the interest rate is 1% lower.
In the third year, the initial approved rate kicks in.
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What is an example of a 2-1 buydown?
To help you visualize how much you could save with a 2-1 buydown, take a look at the following example.
Let’s say you want to purchase a $250,000 home with a 5% down payment ($12,500).
You apply for a $237,500 loan with a mortgage lender and are approved for the loan with a 6.5% fixed interest rate for 30 years.
Without a 2-1 buydown, your monthly loan amount would equal $1,501.
If you qualify for a 2-1 buydown, your interest rate would drop 2% in the first year to 4.5%, and 1% in the second year to 5.5%.
In the third year, your approved 6.5% rate becomes effective.
|Year||Interest rate||Monthly payment||Monthly savings|
Your total savings in the first two years of the loan is $5,412. However, this $5,412 is going to be due at closing as an up-front fee.
Let’s take a look at how the 2-1 buydown process works.
How does a 2-1 buydown loan work?
Your loan officer will need the $5,412 savings up-front to cover the interest the lender will lose in the first two years of your mortgage.
But if you’re a borrower searching for savings, how would a 2-1 buydown save you money if you just have to pay the fee up-front anyway?
Sellers and contractors are currently using 2-1 buydowns as an incentive—or concession—for buyers. This means that they will cover the up-front fee for you.
A 2-1 buydown is beneficial for both buyers and sellers because a buyer will receive a reduced rate in the first two years of their mortgage, while a seller or contractor can sell the home faster—and without having to reduce the asking price.
At closing, the seller will pay the 2-1 buydown fee, and you can enjoy your savings.
The up-front cost is put into an escrow account.
What happens after the first two years of my buydown?
Your loan officer will approve you for a loan based on current interest rates. In the example above, the borrower was approved for a 6.5% rate.
After you take advantage of your buy-down savings in the first two years, your initial approved rate will take effect at 6.5%.
Fortunately, since you were approved at this rate, this means you should be able to comfortably afford it. However, if your circumstances have changed at all in the previous two years, this could become an issue.
It’s important for borrowers to be aware of the monthly mortgage payment increase that will apply after the buydown period ends.
If you’re having financial troubles or are concerned about making your payments on time, talk to your loan officer as soon as possible so they can help you navigate your options.
What if interest rates decrease during my buydown period?
Sometimes interest rates can be unpredictable, even for mortgage experts.
While many analysts are predicting that rates will remain about the same this year, some are predicting that rates will moderate.
Let’s say you are approved for a 6.5% rate after the first two years of your buydown; but once the two years end, average interest rates have fallen to 5.5%.
You may be able to refinance your loan at the end of your two years to access the new, lower rates. Some lenders also will allow you to refinance during the buydown period.
Discuss your options with your lender if you notice rates are beginning to drop.
What are the pros and cons of a 2-1 buydown?
Every loan option has its pros and cons depending on the unique needs and interests of the borrower.
Let’s take a look at the biggest pros and cons of a 2-1 buydown to help you make the right decision for you.
Pros of a 2-1 buydown
- Lower interest rate for two years
- Seller or contractor often will cover the up-front fee as a concession
- Borrower may be able to afford a more expensive home
- Borrower has more time to increase income in the two years leading up to the effective date for the rate agreed to at signing
Cons of a 2-1 buydown
- Interest rate will increase each year of the buydown period
- Borrower risks being unable to afford monthly payments once buydown period ends
The most important consideration for a 2-1 buydown is whether you can afford your monthly mortgage payments as your interest rate increases.
The key to a successful 2-1 buydown loan process is working closely with a loan officer you can trust.
Meeting the loan officer’s requirements will provide the confidence that you are able to make the payments as they go up.
Additionally, open and comfortable communication with your loan officer will help if you need to contact them with any questions or concerns that arise.
What are the requirements for a 2-1 buydown loan?
Compass Mortgage’s 2-1 buydown loan program requires a long-term, fixed-rate mortgage, such as a conventional, FHA or VA loan.
The seller, builder or buyer must pay the up-front cost, which can either be in the form of a lump sum that is deposited into an escrow account or as mortgage points.
To apply, you will share basic information about your potential home purchase and loan needs, and we will obtain your credit report and review your financial situation.
Information needed for the 2-1 buydown program includes:
- Your credit score
- Your income
- Your debt-to-income ratio (DTI)
- Your down payment
There will be closing costs, and you probably will have mortgage insurance. We will inform you about those expenses.
Your loan officer will work closely with you throughout the entire process to find the most affordable loan option for your home.
Apply today for a 2-1 buydown loan with Compass Mortgage
A 2-1 buydown is a smart option in today’s market, allowing borrowers to access significant savings in the first two years of homeownership.
To find out if a 2-1 buydown is right for you, apply with the mortgage specialists at Compass Mortgage today.
At Compass Mortgage, we offer our borrowers more than a standard pre-approval. Our unique Get Committed® program provides a fully underwritten loan commitment that locks in your interest rate before you even find the property you want to buy.
Standard pre-approval does not mean that you have secured a loan. Our distinctive Get Committed® program allows you to go through most of the steps in the loan process to ensure a loan commitment before you even make an offer on a home, thus providing greater confidence to any prospective sellers to whom you make an offer.
Lock in your rate today and move through the lending process faster with the Compass Mortgage team, or contact us for help with your next steps.
We look forward to getting you into your dream home at the most affordable rate.
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