How Much Does a 2-1 Buydown Cost?

Mortgage interest rate buydowns offer homebuyers a strategy to manage initial loan payments by temporarily reducing the mortgage interest rate. Among various options, the 2-1 buydown is a specific type of temporary reduction designed to ease a borrower’s financial transition into a new home. This approach can make homeownership more accessible, especially when market interest rates are elevated.

Understanding a 2-1 Buydown

A 2-1 buydown is a mortgage agreement that temporarily lowers the interest rate for the first two years of a loan. This mechanism reduces the rate by two percentage points in the first year and one percentage point in the second year, relative to the original note rate. After this two-year period, the interest rate reverts to the full, permanent rate for the remainder of the loan term.

This temporary reduction is achieved through an upfront lump sum payment made at closing. The funds from this payment are held in an escrow account, which then supplements the borrower’s monthly payments during the buydown period. A 2-1 buydown does not alter the loan’s underlying interest rate or term; it merely provides a temporary subsidy for a portion of the interest due.

Calculating the Cost of a 2-1 Buydown

The cost of a 2-1 buydown represents the total difference between the reduced monthly payments and the full principal and interest payments over the initial two years. To determine this cost, calculate the monthly interest savings for each of the two buydown years and then sum these savings over the 24-month period.

For example, consider a $300,000, 30-year fixed-rate mortgage with an original interest rate of 6.5%. In the first year of a 2-1 buydown, the effective interest rate would be 4.5% (6.5% – 2%). The monthly principal and interest payment at 4.5% would be lower than the payment at 6.5%. The difference between these two monthly payments, multiplied by 12, gives the total savings for the first year.

In the second year, the effective interest rate would be 5.5% (6.5% – 1%). The difference from the original 6.5% payment is determined, and these monthly savings are then multiplied by 12 to find the second year’s total. Summing the total savings from the first and second years yields the overall cost of the 2-1 buydown.

Factors Influencing the Cost

Several variables influence the final cost of a 2-1 buydown. The loan amount is a factor, as a larger mortgage results in a higher buydown cost. This occurs because the percentage point reduction translates to a greater dollar amount of interest savings on a larger loan principal. For instance, the same 2% reduction on a $400,000 loan will yield twice the savings compared to a $200,000 loan, requiring a larger upfront payment to cover those savings.

The original interest rate also plays a role. A higher underlying interest rate means that the 2% and 1% reductions will lead to greater monthly savings for the borrower, requiring a higher lump sum. The broader market interest rate environment can influence the availability and attractiveness of buydown programs from lenders.

The overall loan term impacts the principal and interest payment from which savings are calculated. While the buydown is limited to two years, the underlying loan’s structure, such as a 30-year term, sets the baseline for payment calculations. Some lenders may also have specific fees or program variations associated with buydowns, which can affect the total cost.

Funding the Buydown

While the homebuyer benefits from reduced initial mortgage payments, the upfront lump sum cost of a 2-1 buydown is frequently covered by a third party. A common scenario involves the home seller offering to pay for the buydown as an incentive to facilitate the sale. This can make a home more attractive to potential buyers, especially in competitive markets or when interest rates are higher.

In new construction, home builders often contribute to the buydown cost to attract purchasers. Less commonly, some lenders might offer credits that can be applied towards the buydown, sometimes in exchange for a slightly higher base rate on the loan. A buyer could also choose to fund the buydown themselves, though this is less frequent for the entire amount.

The lump sum paid by the contributing party is typically placed into an escrow account managed by the lender. Each month, funds are drawn from this account to cover the difference between the borrower’s temporarily reduced payment and the full payment due on the loan.