A 2-1 buy-down is an agreement that allows a homebuyer to pay a lower mortgage interest rate for the first two years of the loan before it rises back to the regular rate.
As the market slowly shifts from a seller’s market to a more favorable environment for buyers, sellers are beginning to offer concessions to help potential buyers afford a home.
What's in this article?
Buyers can use a seller concession in the form of a 2-1 buy-down to access significant savings in the first few years of homeownership.
Let’s take a look at an example of a 2-1 buy-down, the benefits of this mortgage trend and the requirements.
What is a 2-1 buy-down?
A buy-down is a financing method that allows a buyer to get a lower interest rate for the first few years of the mortgage in exchange for an up-front payment.
A 2-1 buy-down is a type of temporary buy-down where the first two years of the loan are at a lower interest rate, with the normal rate taking effect in the third year.
For the first year of the loan, buyers will pay an interest rate that is 2% lower than the approved rate. In the second year, they will pay a rate that is 1% lower than the standard rate.
In the third year, they will pay the permanent interest rate they agreed on at closing.
To make up for the interest that the lender won’t receive in the first few years, the buyer or seller will have to pay a one-time fee at closing that is deposited in an escrow account.
Sellers usually use 2-1 buy-downs as an incentive for potential buyers and will make the upfront payment.
A 2-1 buy-down is a helpful way for buyers to save money in the first few years of homeownership. However, they must be prepared for the rising payments that come each year.
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How does a 2-1 buy-down work?
If a seller is offering a 2-1 buy-down on a home, here’s an example of how it could play out.
Let’s say the home you want to purchase is $315,790, and you want to put 5% down, or $15,790.
Your approved loan amount is $300,000, with a 5.99% rate over 30 years.
In Year 1, you will have an interest rate of 3.99%, and a monthly payment of $1,431.
In Year 2, you will have an interest rate of 4.99%, and a monthly payment of $1,609.
In Year 3, your rate will adjust back to 5.99% for the remainder of the loan, at a $1,797 monthly payment.
The first two years of payment offer substantial savings for the buyer. In the first year, you will save $4,392, and in the second year, $2,256.
Is a 2-1 buy-down similar to an adjustable-rate mortgage?
A 2-1 buy-down and adjustable-rate mortgage are not the same.
The only similarity between the two options is that the initial mortgage rate may be lower.
An adjustable-rate mortgage is a loan option that begins with a fixed rate that is usually lower than a regular fixed-rate loan. Once the established introductory period is over, the rates adjust.
One of the most popular ARM options is the 5/1 ARM, where the lower introductory rate lasts for five years, and then adjusts once a year.
ARM rates are tied to an industry index which is determined by current market conditions. The index can go up or down, which can be a risk to borrowers.
Borrowers may choose to refinance to a fixed-rate mortgage in the future.
On the other hand, a 2-1 buy-down requires an up-front payment to make up for the initial lower rates. The seller usually makes this payment on the borrower’s behalf as an incentive to purchase the home.
When the two years of lower rates are complete, the rate will resume at the original, agreed-upon fixed rate.
What are the benefits of a 2-1 buy-down?
A 2-1 buy-down offers major benefits to buyers, as long as the seller pays the up-front lump sum:
- Lower monthly payments for the first two years of homeownership
- Extra time to budget or save for payments in the full amount
- Potential to afford a larger home
The buyer must make sure they are properly budgeting for the monthly payment increases that will occur each year.
What are the requirements for a 2-1 buy-down?
If a seller is offering a 2-1 buy-down on their property, an interested buyer must find a lender that allows a buy down option.
Buy-downs may not be available for certain property or loan types, depending on the lender.
Compass Mortgage allows borrowers to use a buy down option to help them ease into homeownership.
To get started with Compass Mortgage, apply today for loan pre-approval.
Pre-approval is the first step in the homebuying process, allowing you to find out how much home you can afford and proving to sellers you are a serious buyer.
Get Committed® with Compass Mortgage
Beyond pre-approval, we offer Get Committed®, a loan commitment program which puts you in the best possible position to win the home you truly want.
Get Committed provides a fully underwritten loan commitment and locks in your interest rate before you even find the property you want to buy.
A loan commitment essentially has the power of a cash offer, showing the seller you’re fully approved financially and that your deal isn’t likely to fall through.
Combined with a 2-1 buy-down, you will not only be able to compete with cash offers but have the extra money in your pocket from the savings of buying down the interest rate.
Reach out to our team today to learn more about 2-1 buy-downs and get started with the most affordable loan option for you.
Photo by Elina Fairytale