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  • Minneapolis, MN: They say if you live long enough, you see everything come back around, and that is very true for the 2-1 buydown mortgage loan option that has magically reappeared on the market the past few months.

    Simply put, a 2-1 buydown is a temporary subset of your standard mortgage agreement, like a 30-year fixed, that provides a 2% lower interest rate the first year of the loan, a 1% lower rate for the second year of the loan, and then the normal note rate for the remainder of the loans term (remaining 28-years).

    With mortgage loan interest rates hovering around 7% as I write this, (see current rate averages) the buydown has become popular as a way for builders and sellers to help sell a house with this incentive.

    2-1 Buydown Savings

    Let us look at an example of a 2-1 buydown in action. Assume you are buying a $400,000 home with 20% down on a 30-year fixed rate mortgage at 7% interest. Your initial loan amount is $320,000.

  • Example 2-1 buydown. Assuming real (permanent) rate is 7%.

    YearInterest RatePaymentSavings
    Year 15%$1717$411
    Year 26%$1918$210
    Remaining Years$7%$21280
  • The total savings over the first two years in this example is $7464. Nice, but...

    A 2-1 Buydown is NOT Free

    Nothing in life is free, and that includes the 2-1 buydown. Someone has to pay for it, be it the buyer, seller, builder, or lender. The cost of the buy down will be exactly whatever the buyers savings will equal, and is paid up-front at closing.

    Using our sample buydown above, the cost of the buydown is $7,464.but typically is anywhere between $5,000 to $15,000.

    Who Pays for the 2-1 buydown?

    YOU DO. ALWAYS. I liken this to the ball under the three cups game where they move the cups around, and you have to guess which cup the ball is now under..  The ball is still there somewhere. Just under what cup.  The same with the costs of a 2-1 buydown. The costs are still there.  YOU are still paying.  But how will you be paying for it?

    Home buyers can’t, as it isn’t allowed by lenders.  But why would you? There is no benefit. You would pay up-front to realize the same exact savings over two years.  Basically buyers cannot prepay their own buydown. 

    Home builders will often times advertise a 2-1 buydown incentive, and 'pay' it for you. Don't be fooled. Because this is a massive builder concession, they hide it or  add it onto the price of the home and therefore the home price become artificially inflated. 

    Home sellers will often times also agree to pay for a 2-1 buydown. But same as a builder. Because this is a massive seller concessions, they add it onto the price of the home, or refuse to lower the price of the home. Therefore the home price becomes artificially inflated .

    Your mortgage lender can also pay for a 2-1 buydown for you. This is done by increasing the loans interest rate to cover the cost.  How much the lender has to increase the loans interest rate will vary based on many factors; the current market, the loan type you are getting, your credit score, and more.  Buy maybe raising your permanent rate 1/2% to 1% or more to get a temporary buydown is just bad math.

    Pros and Con of a 2-1 Buydown

    For home buyers, the apparent savings sound great. It can help a buyer be more comfortable with the payment shock a new home can bring by stepping up the payment over the first two years.  It is also nice for those who expect to in increase their income over the next few years. 

    A downside, especially if you are banking on income going up to safely afford the house is... What if it doesn't go up?

    Another downside is the buyer is trapped in their high note rate mortgage for an extended period due to having interest prepaid. This removes them from the ability to refi out the first two years when / if interest rates drop.

    For the current market (Oct 2022), the odds of rates dropping significantly in the next two years is pretty good. You now likely paid a premium for the house to finance a 2-1 buydown on a loan you are almost guaranteed to be refinancing. Ouch.

    Next, is the cost. Could the amount of money spent on the buydown been used better elsewhere?

    A Better Option?

    Is there a better way than a 2-1 buydown?  Maybe...

    For example, instead of the builder, seller, or lender paying for the buydown, how about if they paid for your loans closing costs instead.

    This way you have an immediate cash out of pocket savings, versus payment savings realized over two years. Less cash out of pocket is  something usually very important to first time home buyers lacking cash for their down payment and closing costs.

    Or, would it have made more sense to just lower the cost of the house instead of paying for the buydown?

    In this example, instead of a permanent payment of $2128, a loan $7464 cheaper, would have a permanent payment of $2079, or $49 a month cheaper for 30-years, which works out to be a savings of $17,640.  A full $10,176 better than the buydown.

    Finally, maybe it would have been better to spend the money on a permanent rate buydown.

    For example, that same $320,000 loan example, you saved $7464 with the buydown on a 7% mortgage rate. A 30-year loan at 7% is $446,428 in total interest paid over the life of the loan.  But if you spent the same amount of money on a permanent buydown, maybe you could have lowered the permanent rate to 6.50%, or maybe even lower..  Over 30-years, and at just a 1/2% better rate, that works out to be total interest paid (TIP) of $408,428.  So a savings of $38,000. Of course that is over 30-years, and you may not live there that long.

    The Bottom Line

    The bottom line is like so many things in life, a 2-1 buydown is not as simple as it initially sounds once you drill down the numbers, and understand how it works.

    Is a 2-1 buydown right for you?  Have a good conversation with an experienced licensed Loan officer, like us here at the Joe Metzler Team at Cambria Mortgage.  We can run all your specific numbers to make sure you are getting the best short-term and long-term loan for you and your family.  You can reach us at (651) 552-3681.