What is a 2-1 buydown? Money paid at closing, usually by a seller or builder, that lowers the rate a borrower pays for the first year or two before the note rate takes over.
A buydown is cash paid up front to reduce the interest a borrower actually pays. A temporary buydown reduces it for the first year or two and then stops, and the common shapes are named for the reduction in each year: a 2-1 buydown charges 2 percentage points below the note rate in year one and 1 point below in year two, and a 3-2-1 runs three years. From the year after, the borrower pays the note rate for the rest of the loan.
The money is real and it is spent at closing. Whoever funds the buydown deposits the whole interest difference into an escrow account, and each month the servicer draws from it to make up the gap between what the borrower sends and what the note requires. On a $400,000 loan at a 6.5 percent note rate over 30 years, principal and interest are about $2,528. At an effective 4.5 percent in year one they are about $2,027, and at 5.5 percent in year two about $2,271, so the account has to hold roughly $6,020 for the first year and $3,080 for the second, about $9,100 in all.
Two things follow. The lender underwrites at the note rate, not the reduced one, so a buydown does not stretch what anyone will approve; it lowers the first payments and nothing else. And it is not the same as discount points, which buy the note rate down permanently and cost more for the same first-year saving. Buydown funds are a seller or builder concession, which is why they turn up most in new construction: a builder holding standing inventory would rather fund a buydown than cut the recorded price, because the price is the comp the next homes in the tract are appraised against.
A worked example
A builder offers a 2-1 buydown on a $400,000 loan at a 6.5 percent note rate. Principal and interest at the note rate are about $2,528 a month. The borrower pays about $2,027 in year one at an effective 4.5 percent and about $2,271 in year two at 5.5 percent, and the builder's escrowed deposit of roughly $9,100 covers the difference. From month 25 the payment is $2,528 for the remaining 28 years.
Run the payment at the note rate
Questions people ask
Who pays for a buydown?
Usually the seller or the builder, as a concession written into the purchase contract, though a buyer or a lender can fund one. Whoever pays, the whole amount is deposited at closing into an escrow account the servicer draws from each month.
Do you qualify at the lower buydown rate?
No. The lender underwrites the loan at the note rate, so a 2-1 buydown does not raise the loan amount anyone will approve. It lowers the first two years of payments and leaves the qualifying arithmetic untouched.