What Is The “2-1 Buy-Down”

From the desk of Randy Bristol

I have been getting a lot of questions lately concerning the “2-1 Buy Down”, what it is and how it works. 

The “2-1 Buy-Down” is a program that has been around for a while but has become an attractive program for buyers and sellers in today’s market. While it may seem like a complicated program at first glance, it really is quite simple—and quite beneficial for both buyers and sellers.  

What is the “2-1 Buy-Down”? 

The “2-1 Buy-Down” is a mortgage lending technique that provides for lower mortgage payment during the first two years of the loan. This is not to be confused with an adjustable-rate mortgage “ARM” loan or a loan where the rate is bought down with discount points. This is a program where the sellers actually supplements the buyers’ payments for the first two years of the loan to give them the effect of having a lower interest rate.

How does it work?

In the first year of the loan, the buyer pays a principal and interest payment that is based on an interest rate that is 2% lower than the note (mortgage) rate. In the second year of the loan, the buyer pays a principal and interest payment that is based on an interest rate 1% lower than the note rate. The remainder of the buyers' payments in the term of the loan would be based on the stated interest rate of the note.  

Example 

• “2-1 Buy-Down” for $300,000 loan amount with note rate of 7%. 
• In year 1 of the loan, the buyer would pay principal and interest at a rate of 5% (7%-2%). This equates to savings of $4625.40 for the first year!
• In year 2 of the loan, the buyer would pay principal and interest at a rate of 6% (7%-1%). This equates to savings of $2367.48 for the second year! 
• Total savings for the buyer during the “2-1 Buy Down” comes out to $6992.88! 

Where Does the Money Come From for the “2-1 Buy-Down”? 

The “2-1 Buy-Down” is funded by cash generally provided by the seller or builder at closing (although they can also be funded by the buyer). The funds for the difference in the principal and interest payments for the two years of savings (in our example above, $6992.88) are collected at closing, placed in an escrow account, and drawn upon by the servicer of the loan to make up the full principal and interest payment of the note rate.

These funds, if paid by the seller are considered “Seller paid concessions” or “Seller paid closing cost” and would be listed on the contract as such. They are also calculated in the total allowable closing cost that are allowed to be paid by the seller. It can be further explained in special stips as “All parties agree that the seller contribution towards closing costs in item # 3 of the contract may be used at the buyer’s discretion towards closing costs, pre-paids and/or buydown costs. ”

Who Benefits from the “2-1 Buy-Down”? 

Both buyers and sellers benefit from a “2-1 Buy-Down” in today’s market. In an environment where home sales have slowed, sellers can use a program like this one to help incentivize buyers to buy.

The benefit to buyers is clear. They are given a lower payment for two years. But it is especially appealing to buyers in today's market where buyers would reap the benefits of a lower rate today while hopefully anticipating being able to refinance into a permanent lower rate down the road.  

If you feel like the “2-1 Buy-Down” would be helpful for you or one of your clients, I am always available to help.