Mortgage interest rates are on the rise and, at the same time, the housing market is showing signs of leaving behind the competitive seller’s market we’ve seen for the past few years.
However, home prices are still high, and they may take a while to fall. As a result, buyers are seeking creative ways to save money in their first few years of homeownership.
What's in this article?
Sellers are also more willing to offer concessions to eager buyers since demand is slowing.
One savings option that benefits both buyers and sellers is a 2-1 buy-down, which allows you to pay a lower mortgage interest rate for the first two years of the loan.
Let’s take a look at how a 2-1 buy-down works, what it costs and how to find a lender who offers a buy-down option.
How does a 2-1 buy-down work?
In the first year of homeownership, a 2-1 buy-down gives borrowers an interest rate that’s 2% lower than their approved rate.
In the second year, they will have an interest rate that’s 1% lower.In the third year, the standard, approved rate will go into effect for the remainder of the loan.
In exchange for the two years of lower rates, the borrower must pay an up-front fee at closing that usually goes into an escrow account.
However, this deal isn’t much of an incentive if the borrower is paying the up-front fee.
Sellers usually will cover this fee as a concession to a buyer, because taking this step will encourage the buyer to move ahead with the deal and prevent the seller from having to significantly lower their price.
Ready To Take Your Next Step?
How does a 2-1 buy-down help me beat high-interest rates?
A 2-1 buy-down helps buyers beat high-interest rates by providing a 2% relief in the first year and a 1% relief in the second year.
While it may not seem like much, this reduction can add up to thousands of dollars.
Let’s take a look at an example of the amount of savings a 2-1 buy-down can offer to borrowers.
Imagine you are purchasing a home for $425,000, with a 10% down payment. Your mortgage loan amount is 382,500, with a 5.25% fixed rate over 30 years.
With a 2-1 buy-down, your interest rate in your first year would be 3.25% and a monthly payment of $1,665.
In your second year, your interest rate would be 4.25%and a monthly payment of $1,882.
In your third year, your 5.25% approved rate will kick in with a monthly payment of $2,112.
In your first year of homeownership, you will be paying $447 less per month with a 2-1 buy-down than you would if you had your full approved rate. In the second year, you will save $230 per month.
What does it cost?
In our 2-1 buy-down example, the borrower has a total savings of $8,124 in the first two years of the loan.
This $8,124 fee must be paid up front closing for the 2-1 buydown to take effect.
If the seller is offering this option to you as a concession, they will pay this fee.
In less competitive markets, sellers often have to lower their sales prices. Some sellers feel that paying an $8,124 fee is better than having to significantly lower their sales price, so it’s worth it to them to offer this as a buyer concession.
When can I refinance in a 2-1 buy-down?
What happens if interest rates drop while you’re in the first few years of your 2-1 buy-down?
The rules are up to your lender, but you may be able to refinance during the buy-down period to secure a lower rate permanently.
Or, if rates drop after the two years are up, you are free to refinance to secure a lower rate and continue with lower monthly payments.
One of the biggest challenges for those in a 2-1 buy-down is navigating the raising rates over those two years. You’ll want to make sure you’re able to scale up to afford the rising rates.
How is a 2-1 buy-down different from an adjustable-rate mortgage?
A common question concerning 2-1 buy-downs is how they differ from adjustable rate mortgages (ARMs) since rates for ARMs also adjust over time.
ARMs offer lower introductory rates that adjust after a set period of time.
Similar to a 2-1 buy-down, borrowers with an ARM will need to make sure they can afford a higher rate if rates go up after the introductory period.
But unlike an ARM, a 2-1 buy-down promises a fixed rate after the two lower-rate years are complete. You’ll know from the start how much your loan amount will increase over time.
How do I find a 2-1 buy-down loan?
Not all mortgage lenders offer a 2-1 buy-down loan option; so if you’ve connected with a seller who is offering this option to you, you’ll have to find the right lender.
Get committed with Compass Mortgage
Compass Mortgage allows borrowers to use a 2-1 buy-down to save money in the first few years of homeownership. We care about your financing needs and want to make owning a home as affordable as possible.
Get started today by applying for our Get Committed loan commitment program, which provides a fully underwritten loan commitment and locks in your interest rate before you even find the property you want to buy.
With Get Committed, you can access the following benefits:
- A fully vetted loan commitment
- Competitive offer without it necessarily being the highest price
- Secure your interest rate upfront
- Close in as fast as 15 days
Armed with our Get Committed program and a 2-1 buy-down, you’ll be off to a strong start as you enter the adventures of homeownership.
Connect with our team today to get started on the loan process.
Photo by cottonbro