A 2 – 1 buydown temporarily lowers your mortgage payments at the start of the loan term by using a stair-stepped interest rate over the course of three years. The rate starts low for the first year, then increases in the second year and finally reaches its full (and final) rate at the start of the third year. But someone has to pay for this perk – which can be either the buyer or the seller, depending on circumstances and negotiations.
Find out more about how a 2 – 1 buydown works, its benefits and the potential drawbacks.
- A 2 – 1 buydown lowers your interest rate for the first two years of the mortgage.
- Sellers or construction companies may pay for the buydown in a buyer’s market.
- The buyer must qualify for the mortgage before taking the 2 – 1 buydown into consideration.
- Many lenders limit 2 – 1 buydowns to primary residences and second homes, though eligibility varies by loan program and lender.
What Is A 2 – 1 Buydown?
A 2 – 1 buydown provides a borrower with a temporarily lower rate to help decrease monthly mortgage payments for the first two years of the loan term. This type of financing arrangement is allowed on either a primary or secondary home, but not investment properties.
The interest rate usually starts 2% lower than the eventual rate in the first year of the loan, then increases by 1% in the second year. Starting in the third year, the full interest rate and mortgage payments are in place for the remainder of the loan term.
The main benefit is that the borrower gets some financial breathing room during the first two years of the mortgage. But it’s not free to implement a 2 – 1 buydown. An upfront amount is charged to cover the lender’s lost interest during the first two years. The cost equals the difference between the reduced payments during the first two years and the full payment amount. In many cases, this ends up being roughly 1.5% – 2.5% of the loan amount, depending on the interest rate and loan size.
The funds are paid up front and held in an escrow account, then distributed as part of the monthly payment during the first two years of the loan.
Who Pays For A 2 – 1 Buydown
The ideal situation, of course, is to get someone else to pay for the buydown and enjoy the lower mortgage payments. The most common scenario is for the seller (when buying an existing home) or the builder (when buying new construction) to cover the 2 – 1 buydown fees as a negotiation concession. Some lenders or builder-affiliated lenders may offer buydowns as promotional incentives.
While this strategy likely won’t work in a highly competitive real estate market, it may be easier to negotiate if sales are slow or if there is a lot of new construction in the area.
As the home buyer, you can also pay for a 2 – 1 buydown on your own. But it doesn’t always make sense to spend cash up front just to lower your mortgage payment for two years. You’ll end up paying the same amount and you may need that extra cash for other expenses like your down payment and closing costs. Plus, you still need to qualify for the monthly payment using your final interest rate.
Example Of How A 2 – 1 Buydown Works
Here’s how a 2 – 1 buydown mortgage looks in a hypothetical situation. Let’s say you purchase a $500,000 new-construction home and make a 10% down payment. You qualify for a 7% interest rate with a 30-year term, but the builder is offering to pay for a 2 – 1 buydown to incentivize buyers.
In this scenario, your loan amount would be $450,000. During the first year of your mortgage, your interest rate would only be 5%. In year two, it would increase to 6%. In year three, you would reach your final, fixed interest rate of 7%.
What would that mean for your monthly payments? Let’s take a look:
- Year 1: $2,416 per month
- Year 2: $2,698 per month
- Year 3: $2,994 per month
Between years 1 and 3, your monthly payments will increase by $578. In total, a 2 – 1 buydown would save about $10,488 in this scenario ($6,936 in year 1, and $3,552 in year 2). For many new homeowners, that extra cash could help cover things like moving and furniture costs or recuperate the savings spent on a down payment.
The final $2,994 payment would be your permanent monthly mortgage cost for the remainder of the term. You can use an amortization calculator to figure out the savings with a potential 2 – 1 buydown on your own particular circumstances.
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How To Qualify for a 2 – 1 Buydown Mortgage
Both the borrower and the property itself need to meet a few criteria in order to get a 2 – 1 buydown on a mortgage.
Borrower Requirements For A 2 – 1 Buydown
In order to qualify for a 2 – 1 buydown, you need to meet the lender’s typical criteria for all of the final loan terms. Here are the primary factors lenders look at during the mortgage qualification process:
- Financial assets and documentation
- Credit score
- Debt-to-income ratio
- Home appraisal
- Ability to pay down payment and closing costs
If you’re approved based on this information, you’ll receive a loan estimate from the lender. This will include your maximum loan amount, your interest rate and your loan term. One thing to remember: Even if a seller or construction company is paying for a 2 – 1 buydown on your behalf, you still need to qualify for the loan based on the final interest rate, not the temporarily reduced rate.
The reason? Lenders want to make sure you can still afford the monthly payments after the 2% rate increase. In our hypothetical scenario above, for example, the payment increased by over $550 a month between years 1 and 3. You can see how the cost increase could be quite significant, depending on the size of your mortgage and your interest rate – especially if you’re already at the top of your approved budget.
It’s also important to remember, if you’re considering a government-backed loan such as an FHA, USDA, or VA loan, these have their own specific guidelines for buydowns and how they can be used.
Property Requirements For A 2 – 1 Buydown
In order for a property to be eligible for a 2 – 1 buydown, it must serve as either your principal residence or second home. Many lenders limit buydowns to purchase transactions and may restrict them on investment properties or cash-out refinances.
On top of that, your total amount financed must meet the DTI and credit score requirements for the higher (original) interest rate (and the correlating higher payment).
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Pros And Cons Of A 2 – 1 Buydown
There can be both benefits and drawbacks to a 2 – 1 buydown. Here are some to consider before you move forward with this type of financing.
Pros
- Lower mortgage payments for the first two years
- Gives you time to financially recoup from up-front home-buying costs
- Could be paid for by the seller or construction company, or by the lender
Cons
- Must still qualify for the final monthly mortgage payment
- Must budget for the higher payment amount that will result in year three (when the lower rate from the buydown concludes).
- May not be worth it if buydown isn’t covered by seller, construction company or lender
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2 – 1 Buydown Vs. Adjustable-Rate Mortgage Vs. Discount Points
A 2 – 1 buydown isn’t the only way to lower your mortgage payments at the beginning of your loan term. Other options include an adjustable-rate mortgage and discount points, especially if you don’t have access to concessions that will cover the buydown costs on your behalf.
How Does An Adjustable-Rate Mortgage Work?
An adjustable-rate mortgage (ARM) is a type of mortgage that starts with a lower interest rate, but offers less certainty in how much you’ll pay in the future compared to a fixed-rate loan or a 2 – 1 buydown. You’ll begin by paying a lower rate at the beginning of an ARM for a certain amount of time. Once this fixed-rate period ends, the rate adjusts based on the current rate index.
That means your monthly payment could increase or decrease, depending on which direction rates have headed since you got the loan. After the fixed period ends, the interest rate adjusts periodically based on a benchmark index.
How Do Discount Points Work?
Like a 2 – 1 buydown, discount points help to lower your interest rate. The main difference, however, is that points make your buydown permanent, not simply temporary for a two-year period. Each discount point usually costs 1% of the loan amount and may lower the interest rate by roughly 0.125% – 0.25%, depending on market pricing.It’s paid at closing and is tax deductible if you itemize your taxes
The downside is that, given the cost of discount points, you could end up losing money if you sell your home before you break even on the interest saved.
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2 – 1 Buydown Mortgage FAQs From Quicken Loans
Is a 2 – 1 buydown a good idea?
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The Bottom Line: Is A 2 – 1 Buydown Right For You?
A 2 – 1 buydown can be an effective way to lower your monthly payments for the first two years of your mortgage. But it may not make sense to pay for the buydown yourself, since you’ll need to qualify for the final-rate monthly payments anyway. An ideal scenario would be to get the seller or construction company, or the lender, to purchase the buydown on your behalf, if you can.
Ben Shapiro
Ben Shapiro is an award-winning financial analyst with nearly a decade of experience working in corporate finance in big banks, small-to-medium-size businesses, and mortgage finance. His expertise includes strategic application of macroeconomic analysis, financial data analysis, financial forecasting and strategic scenario planning. For the past four years, he has focused on the mortgage industry, applying economics to forecasting and strategic decision-making at Quicken Loans. Ben earned a bachelor’s degree in business with a minor in economics from California State University, Northridge, graduating cum laude and with honors. He also served as an officer in an allied military for five years, responsible for the welfare of 300 soldiers and eight direct reports before age 25.
