In times of higher mortgage rates, or just to have a gradually increasing mortgage payment over 24 months, it may be helpful to consider a 2-1 Temporary Buydown on mortgage rate when purchasing a property.
A 2/1 Temporary Buydown provides the buyer a discounted mortgage interest rate for the first 2 years of the loan term. The funds to pay for the buydown are deposited into an escrow account to pay the difference in rate for the two buydown years. So the full principal & interest payment is actually being made, just not fully by the Buyer, for first two years.
The Seller (or Builder if new construction) are the sources of the buydown funds. The lender or borrower or Realtor cannot supply the buydown funds. The funds would be contributed by a Seller using a Seller Closing Cost Credit on the purchase contract given to the buyer at closing. The funds are then used to buydown the mortgage rate for the first 2 years of the loan term.
The buydown funds are drawn by the mortgage lender or servicer and used to reduce the borrower’s principal & interest payment each month until the third year, when a borrower begins making the full mortgage payment at the full rate. During the buydown two years, taxes and insurance are still collected from borrower as part of their payment each month.
The borrower must still qualify for the mortgage at the full original mortgage rate before the rate buydown.
An example below may be helpful to explain how a 2/1 Buydown will work-
| Purchase price | $300,000 | |
| 5% down payment | $15,000 | |
| Mortgage size | $285,000 | |
| Full mortgage rate | 7% | (assume a 30 year loan term) |
| 2/1 Buydown rate 1st year | 5% | (rate is 2 percent less for months 1-12) |
| 2/1 Buydown rate 2nd year | 6% | (rate is 1 percent less for months 13-24) |
| Rate in years 3 to 30 | 7% | (2 year buydown period ends at start of 3rd year or with the 25th payment) |
The cost of the 2/1 Temporary Buydown is calculated as below-
Total Buydown Cost / Purchas Price = Seller Credit to Pay for Buydown
In this example the Buydown cost is $6642.72 / $300,000 = 2.214% of $300,000 sale price
$6642.72 cost of Buydown is the sum of annual savings in Year 1 + Year 2 savings as down below or $4394.04 year 1 + 2248.68 year 2 = $6642.72
In this example, the Buyer would ask for a Seller Concession or Closing Cost Credit of 2.214% of the $300,000 sale price or a flat $6642.72. These funds are then held in escrow and added to the Buyers reduced payments for first 24 months of the term. In this way the full 7% rate payment is still made, just not totally by the Buyer.
Below are the monthly payments for each of the two years the 2/1 Temporary Buydown is in effect. We will assume monthly property tax escrow is $500; monthly home insurance escrow is $75.00 and monthly mortgage insurance cost is $100.00. Each of these will always be included in monthly payments.
Year 1
| Interest Rate 5% in Year 1 | |
| Full 7% Monthly Principal & Interest payment | 1896.11 |
| Buydown Principal & Interest Payment | 1529.94 |
| Total Monthly Payment with Escrows | 2204.94 |
| Monthly Savings Year 1 | 366.17 |
| Annual Monthly Savings Year 1 | 4394.04 (Used for Buydown Cost) |
Year 2
| Interest Rate 6% in Year 2 | |
| Full 7% Monthly Principal & Interest payment | 1896.11 |
| Buydown Principal & Interest Payment | 1708.72 |
| Total Monthly Payment with Escrows | 2383.72 |
| Monthly Savings Year 2 | 187.39 |
| Annual Monthly Savings Year 2 | 2248.68 (Used for Buydown Cost) |
Cost of 2/1 Temporary Buydown is the annual Principal & Interest Savings in Year 1 and Year 2 added together or 4394.04 + 2248.68 = 6642.72
It is the $6642.72 that must be provided by the Seller to fund the 2/1 Temporary Buydown as a Seller Closing Cost Credit to Buyer.
Years 3-30
| Full 7% Monthly Principal & Interest payment | 1896.11 |
| Total Monthly Payment with tax, insurance escrows *and mortgage insurance if still required | 2571.11 |
In order for a Seller to feel comfortable providing the funds for the 2/1 Temporary Buydown, it may be the Buyer will have to offer a higher price than without the Buydown requested Seller Closing Cost Credit or Seller Concession.
The Buyer and Seller will sign a 2/1 Temporary Buydown Agreement at closing.
Using a 2/1 Temporary Buydown may ease the financial cost of home buying and gradually allow the buyer to adjust to making the full mortgage payment after 24 months of a reduced payment.
If the home should be sold or mortgage refinanced within the first 24 months of a 2/1 Temporary Buydown, the remaining Buydown funds are applied to reduce the amount of principal payoff of the mortgage on the home being sold or refinanced. The Buydown funds are never lost to the Buyer or wasted.
Some Buyers may use the 2/1 Temporary Buydown as a strategy for a reduced monthly payment, while waiting for a future drop in interest rates overall, to then refinance the original 30 year mortgage to a lower rate 30 year mortgage, if the opportunity to do so arises during the 24 month Buydown period.
The 2/1 Temporary Buydown can be used on a Conventional, FHA, VA or USDA mortgage.
Perry Farella NMLS ID: 755943
773-793-8803 perry.farella@fcmhomeloans.com Perryfarella.com
Down payment and terms shown are for informational purposes only and are not intended as an advertisement or commitment to lend. Please contact us for an exact quote and for more information on fees and terms. All loans subject to credit approval. Rates and fees subject to change. Not all borrowers will qualify.
