DEFINITION of 2-1 Buydown
A 2-1 buydown is a type of mortgage with a set of two initial temporary-start interest rates that increase in stair-step fashion until a permanent interest rate is reached. The initial interest rate reductions are either paid for by the borrower in order to help them qualify for a mortgage, or might be paid for by a builder as incentive to purchase a home.
BREAKING DOWN 2-1 Buydown
Sometimes the cost of a buydown, which is an upfront payment to reduce monthly mortgage payments, is calculated and placed in an escrow account where each month a certain amount is paid out equal to the difference in the temporary mortgage payment and what the eventual mortgage payment will be. Other times, the cost of the buydown is treated like a traditional mortgage point. A thorough analysis should be conducted by the borrower to ensure that a buydown is economical in either situation.
Ways Borrowers Can Benefit from a 2-1 Buydown
The terms of a 2-1, or 2/1, buydown can vary by lender. For example, with a Federal Housing Administration loan, if a 2-1 buydown option is available, the borrower could make a buydown payment that would reduce the monthly mortgage for two years on a 15-year or 30-year term loan. During the first year of the buydown, the mortgage note rate could be reduced 2% on monthly payments. The following year, that reduction would diminish to 1%.
Once the buydown period has expired, the borrower would make full monthly payments for the remaining 28 years of the term.
One of the features of a 2-1 buydown is that it affords the borrower the chance to build up their finances to better accommodate the mortgage payments. Furthermore, it may allow them qualify to purchase a home at a higher price than they could normally afford. Part of the assumption is that the borrower’s salary will increase during this timeframe, thus giving them greater leeway to pay for the remaining life of the mortgage.
Choosing such a buydown based on expectations of income increases may present a risk of the borrower’s household salary does not rise at the anticipated rate. If the borrower does not see income increase on a par with the payments that will be due after the buydown has expired, they could face losses.
Such an option for an FHA loan is typically only available on fixed-rate mortgages. Furthermore, the 2-1 buydown would only be available for new mortgages, not for refinancing or to make adjustments to an existing loan.