Are you looking for options to make lower mortgage payments for the first couple of years? Consider a 2-1 buydown mortgage. This type of financing lowers the interest rate on a mortgage for the first two years, up to two percentage points lower the first year. Then, the mortgage will rise to its regular permanent rate. Whether you expect to move soon or need lower payments while you build your career, this mortgage could offer a solution. Read on to understand this type of mortgage and whether it will work for you.
Understanding 2-1 Buydown Mortgages
A 2-1 buydown mortgage is a mortgage loan where the interest rate starts lower than the prevailing market rate for the first two years, then gradually increases in the third year to the market rate and remains fixed for the remainder of the loan term.
Normally, with a 2-1 buydown mortgage, as the name implies, you'll get a rate of two percentage points in the first year and one percentage point in the second year. Sellers and homebuilders may offer a 2-1 buydown to attract more buyers. As a homebuyer, a 2-1 buydown can be a good deal as long as you can afford the higher monthly payments when those begin.
How Does a 2-1 Buydown Mortgage Work?
A buydown is a real estate financing technique. With this mortgage option, borrowers may have an easier time qualifying for a mortgage with a lower interest rate. That lower rate may last for the duration of the mortgage or for a particular period of time. You'll need to pay extra points upfront to the lender. A 2-1 buydown is one kind of temporary buydown that lasts for two years to qualify for a lower interest rate.
The key characteristic of a 2-1 buydown mortgage is the lower interest for the first two years of the mortgage. The interest rate will typically start around two percentage points below the final rate. That will increase to one percentage point below the final rate in the second year before settling in the permanent interest rate.
While that sounds like you'll save a lot of money, lenders compensate for the loss of interest by charging an additional fee called the buydown.
When securing a 2-1 buydown mortgage, the buyer or the seller can pay for the buydown. You can pay with mortgage points or a lump sum deposited in an escrow account with the lender and used to subsidize your reduced monthly payments for the first two years. Sellers often offer a 2-1 buydown as an incentive to close the deal with potential customers.
Pros of 2-1 Buydown Loans
A 2-1 buydown loan has significant advantages, from lower interest rates to greater affordability. Here's why you should consider a 2-1 buydown mortgage.
Lower Initial Interest Rate
A 2-1 buydown mortgage offers a lower interest rate in the first two years than a traditional mortgage. This can result in lower monthly payments during the initial loan period. This can help buyers expecting a pay raise or a new career with a higher salary. It's also helpful for buyers who want to focus on saving more in the first few years of homeownership.
Affordability for Borrowers
The lower initial interest rate can make homeownership more affordable for borrowers, especially in the early years of the mortgage when they may have other financial obligations or limited income. By reducing the monthly mortgage early on, you can potentially qualify for a larger mortgage or use the savings for renovations, decorations or additional savings.
Cons of 2-1 Buydown Loans
There are some significant advantages of a 2-1 buydown mortgage but also a disadvantage to consider.
Higher Interest Rates in Future Years
After the initial two-year period, the interest rate on a 2-1 buydown mortgage typically increases. This means borrowers may have to make higher monthly payments in the remaining years of the loan, which can strain their budget. As long as you don't take out a mortgage larger than you can afford, you can benefit from a smaller payment in the first years and plan for the future.
Potential Financial Risk
If borrowers are not prepared for the increase in interest rates after the initial period, they may face difficulties in making higher monthly payments. This can lead to financial stress and potentially the risk of defaulting on the mortgage. Likewise, if the buyer’s financial situation changes in the next two years, the larger mortgage payment can cause additional strain.
How Long Is the Loan Term for a 2-1 Buydown?
The loan term for a 2-1 buydown mortgage can vary depending on the lender and borrower's needs. It is typically available for 15- or 30-year terms. With a longer term, you'll have lower monthly payments but pay more interest. With a shorter term, like 15 years, you'll need to make higher monthly payments but will save more in interest overall.
Who Should Consider a 2-1 Buydown?
Home buyers planning to sell their property within the first few years can benefit from a 2-1 buydown mortgage. In addition, if you anticipate increased income in the future, you may find a 2-1 buydown mortgage beneficial to help you manage the payments while working toward that pay increase.
How to Qualify for a 2-1 Buydown
Qualifying factors for a 2-1 buydown mortgage are similar to traditional mortgage loans and include factors such as credit score, income, employment history and debt-to-income ratio.
You'll need to provide the lender with:
- Government-issued ID
- Proof of income such as W-2s or pay stubs
- Bank statements
- Proof of any assets or savings
- Debt
Generally, the higher your credit score, the easier the qualification and potentially the lower the best available interest rate.
Get the Best 2-1 Buydown Loan from Benzinga’s Top Mortgage Lenders
The best 2-1 buydown mortgage lenders offer significant advantages. Find lenders to help you get the best terms here.
Securing a Buydown Loan
A 2-1 buydown mortgage can be the first step to buying your dream home. With lower interest for the first two years, you could use that additional savings for renovations, repairs or to build long-term savings. The only risk is that the payment after two years will be a financial strain, so plan ahead and choose a final payment amount you're sure you can afford. Ready to get started? Find the best mortgage lenders here.
Frequently Asked Questions
Can a 2-1 buydown mortgage be refinanced?
Yes, you can refinance a 2-1 buydown mortgage. If you refinance within the first two years, the unused amount of the 2-1 concessions will count toward the principal at the time of closing. Find the best refinance mortgage lender options here.
Can I prepay my mortgage during the initial two years?
Whether you can prepay your mortgage during the initial two years depends on the lender’s terms. Many lenders will let you overpay up to 10% per year without penalties. You could be charged for paying your mortgage off early or paying over your agreed monthly limit.
Is a 2-1 buydown mortgage suitable for first-time homebuyers?
A 2-1 buydown mortgage can be a good solution for first-time homebuyers. It can help you save more to make repairs, upgrades or save more.
About Alison Plaut
Alison Plaut is a personal finance and investing writer with a sustainable MBA, passionate about helping people learn more about wealth building and responsible debt for financial freedom. She has more than 17 years of writing experience, focused on real estate and mortgages, business, personal finance, and investing. Her work has been published in The Motley Fool, MoneyLion, and she regularly contributes to Benzinga.