Clearing the Fog: Explanation of the 2-1 Buydown

Below is a detailed explanation of a 2-1 rate buydown for a 30 year fixed mortgage, and how it can be advantageous for a builder/broker to offer this program to a potential buyer. 

Basically, a 2-1 buydown means the note rate on the loan is "bought" down, 2% for the first year, 1% for the second year and for years 3-30 the loan "caps," at it's fully indexed market rate.  This loan is particularly appealing to those borrowers skeptical of the current mortgage market. 

Taking a loan significantly lower than the current market rate in effect opens a 3 year window with which the borrower has time to refinance should the rates come back down.  If rates do not drop, or if they go up the buyer has the peace of mind of knowing he/she has the lowest available interest rate at that time.

This loan would appeal to a prospective buyer who may have just taken a new position, relocated or graduated from College.  The buyer may have a guaranteed wage increase within two years, making this 2-1 buydown very attractive as he/she can buy the home he/she wants now, and make the fully indexed payments later.

This mortgage should not be confused for an Adjustable Rate Mortgage, it is simply a 30 year fixed with graduated payment for the first two years.  The borrower is qualified at the fully indexed rate, and the rate can never go above the market rate set at lock in.

The cost can be paid any number of ways.  The seller can offer the buydown as a buyer incentive, it can be paid by a DPAP or gift, or it can be paid by the lender.  The difference in payments is staggering, especially on larger loans.

I am including an example below of the savings a borrower will realize on a $300,000 mortgage at a note rate of 6.5%. 

In this example the total cost of the buydown to the lender, borrower, or seller would be $6,827.64.  This cost can be split between the lender and seller as well.

In contrast, for simplicity's sake let's say the seller offered a $6,827.64 reduction in costs as an incentive to the buyer.  For the Seller's bottom line there is no difference between the price reduction and the buydown, but a 30 year fixed mortgage of $293,172.36 at a market rate of 6.5% leaves the buyer with a payment of $1,853.05/mo.

For a buyer that is not concerned with the rate, or the initial payment on the home, the cheaper sales price yields a larger savings over the 30 year period ($15,534.00).  However, most homeowners refinance their home at least once, most every 3-5 years, and you are this homeowner, you would never realize the reduction in sales price cost wise like you would the buydown.

Clearly we are talking about two different borrowers here.  One is skeptical of the market or new to the housing market, the other is an experienced borrower who may choose not to refinance.  In these two cases, different loan options will yield different results for the two buyers, however knowing these options and being able to take advantage of your options means you are an empowered buyer!.