Buyers and Sellers Can Win With 2-1 Buydowns

As home sales slow, price reductions soar, and mortgage rates increase, motivated sellers and builders are leveraging interest rate buydown incentives to make their homes more attractive and affordable.

This type of mortgage assistance may help offset the impacts of the market cool down, bridging the gap between what sellers want or need and what buyers are willing or able to pay. A win-win for both parties.

The idea is straightforward: Sellers and builders can make their home listings more attractive to buyers by lowering the buyer’s monthly mortgage payments. This financing strategy of sellers and builders paying money upfront to the buyer's lender in exchange for a temporary reduction in the mortgage interest rate is known as a 2-1 buydown.

Experienced real estate agents know about these clever financing tactics to help their clients confidently move forward. Partner with a trusted advisor so you can leverage this concept to help market your property for sale or help you secure financing for your next home.

Curious to understand how 2-1 buydowns work? Let’s dive into the details:

What Is a 2–1 Buydown?

According to Investopedia.com, a 2-1 buydown is a type of financing that provides a temporary low interest rate for the first year of the loan, a somewhat higher rate for the second year, and then the full, permanent rate for the third and later years. The rate is typically two percentage points lower during the first year and one percentage point lower in the second year.

The market is shifting, and motivated sellers, including home builders, may consider marketing their listing with the offering of a 2-1 buydown to make a property more attractive and affordable to buyers. 2-1 buydowns provide relief to buyers with a reduced monthly payment for the first two years, which helps offset the cost of moving. This is a good deal for buyers, provided that they can afford the higher monthly payments in year three. That said, many lenders now offer a free refinance after two years if rates have dropped, making this program even more attractive.

How Do Seller Paid 2–1 Rate Buydowns Work?

A 2-1 buydown is considered a “seller concession.” A seller concession is when lenders allow the seller of a home to “credit” a portion of their proceeds to the buyer. Experienced real estate professionals and builders know that seller concessions can also be used to pay mortgage points and buy down the interest rate.

In this circumstance, the buydown can be in the form of mortgage points or a lump sum deposited into an escrow account with the lender and used to subsidize the borrower’s reduced monthly payments.

How Much Does a Rate Buydown Cost?

It’s reasonable to think that the seller actually “buys down” the interest rate. After all, that’s what the name “2-1 buydown” suggests.

However, that’s not what’s happening. Instead, the rate stays the same for the entire loan period, and a portion of the payment gets prepaid at closing. A 2-1 buydown costs the difference between the standard mortgage payment and the reduction in payments for two years. The rate is reduced by 2% the first year and 1% the second year.

For example, let’s look at the cost of a 2-1 buydown on a $500,000 home with a 7% interest rate and 0% down.

While this can be an attractive option to sellers, builders, and buyers, this may not work for everyone. We’ve listed some pros and cons to discuss with your agent and lender to determine your best course of action.

What are the Pros and Cons of a 2-1 Buydown?

For sellers, a 2-1 buydown can attract more offers at higher prices and sell their homes faster. In turn, this could lead to higher net proceeds for the seller. Buyers can afford more if sellers make concessions to help reduce the loan cost and the monthly mortgage payment for the buyer. This approach also helps avoid the stigma of price reductions.

For buyers, a 2-1 buydown can help them afford more if sellers make concessions to help reduce the cost of the loan. In addition, it gives buyers additional time before their monthly mortgage payments increase. However, it is a risk for buyers if their income won’t support the increasing monthly mortgage payments down the road. Note that buyers still have to qualify, assuming the full payment. So a 2-1 buydown doesn't help a buyer qualify for the loan if their debt-to-income ratio is too high.

Pro tip:  Even when a seller is not offering a buydown, buyers can still include a seller buy-down concession in their purchase offer. Making an offer close to the home's market value will be critical to making seller-paid rate buy-downs work. This is because the home appraisal is a key component of the deal, and if the appraisal comes in less than the purchase price, then a seller-paid rate buy down could be less effective. In this scenario, either the buyer or seller must bring the difference amount to closing.

When Should You Use a 2-1 Buydown?

Sellers may want to pay for a 2-1 buydown if they are having trouble selling their home and want to offer buyer-friendly incentives. This creative tactic may also minimize the need to make price reductions down the road as the market continues to cool.

A 2-1 buydown is a good consideration for buyers who need a lower initial payment but don't want an adjustable-rate mortgage (ARM). If your household income is likely to increase in the next two years, or you need the benefit of lower initial payments while repairs and the upfront costs of homeownership are in play, this could be a good technique for you.

Buyers should work with an experienced agent to help them understand if they are getting a fair deal. Some sellers may increase the price of the home to offset the 2-1 buydown cost. Buyers should also carefully consider their income when looking into a 2-1 buydown, as it is a temporary solution, and they will need to be able to afford the higher payments later on.

Buydowns may not be available from all lenders or combined with all loan types. Having a trusted real estate expert on your side will be the key to your success in the current housing market. Connect with an agent today and start strategizing your next move!