In exchange for a lower rate, the difference is paid through a one-time fee, or point, when you close on your home. This fee is usually deposited in an escrow account, and a small amount is paid out every month to cover the difference. Through this process, you are essentially buying your way into obtaining a lower interest rate for a two-year period.
Alternate name: temporary buydown
How a 2-1 Buydown Works
With a 2-1 buydown loan, the borrower pays a lump sum upfront, ensuring a temporarily lower interest rate for the first two years of homeownership. To help you better understand a 2-1 buydown, let’s look at an example of how one would play out. Let’s say you’re purchasing a $250,000 home with a 5% fixed interest rate. If you agree upon a 2-1 buydown, you’ll pay 3% in interest for the first year of homeownership. During that year, your monthly mortgage payment would be $1,337.34. After that year is up, your interest rate will go up to 4% and your monthly payments would go up slightly to $1,476.87. After the two years are up, you’ll begin paying your permanent rate of 5% and your monthly payments will stay at $1,766.17. This arrangement allows you to save money on your monthly mortgage payments during those two years. During the first year of your 2-1 buydown, you’ll save $428.83 per month and during the second year, you’ll save $289.30 per month. Of course, the difference of $8,617.56 has to be paid upfront and deposited into an escrow account.
Pros and Cons of a 2-1 Buydown
Pros Explained
Pay less money upfront on your monthly payments: With a 2-1 buydown, your interest rate is lower for the first two years of homeownership. As a result, your monthly payments will be lower than a traditional payment plan too. Eases you into making monthly mortgage payments: Making lower mortgage payments for the first two years can be a good way to ease into homeownership. This way, you’ll become more accustomed to the process and save money, too. Saves you money during the first two years of homeownership: Due to the reduced rate, you can save the difference in your mortgage payments. This way, you can save for other short- and long-term financial goals.
Cons Explained
Comes with a high upfront cost: A 2-1 buydown is really only worth the price if you can get the seller to pay the escrow deposit. Otherwise, you’ll have to pay a large upfront fee. Potential problems with escrow: If, for any reason, the escrow agent doesn’t send the payment, then the mortgagor (i.e., you) would be responsible for paying the difference.
Alternatives to a 2-1 Buydown
If you’re interested in a buydown program, but you’re not sure if a 2-1 buydown is right for you, here are a few alternatives you can consider.
1-0 Buydown
With a 1-0 buydown, you’ll pay an interest rate that’s 1% lower than the agreed-upon rate during your first year of homeownership. For example, if your regular interest rate is 5%, it’ll be 4% for the first year. You won’t lower your mortgage payments as much as you would with a 2-1 buydown, but you’ll also have to pay less money upfront.
1-1-1 Buydown
With a 1-1-1- buydown, you’ll pay an interest rate that’s 1% lower for the first three years of homeownership. This can help you ease into your mortgage payments before the interest rate deduction expires.
3-2-1 Buydown
In a 3-2-1 buydown, your interest rate will be 3% lower the first year, 2% lower the second year, and 1% lower the third year before adjusting to your fixed rate. This is a great way to lower your monthly mortgage payments, but the initial escrow payment could be substantial.
