What Is a 2:1 Buydown and How Does It Work?

A 2:1 buydown is a mortgage financing strategy that temporarily lowers a borrower’s initial interest rate and monthly payments. This temporary measure provides a structured reduction in housing costs during the first two years of a mortgage, making homeownership more accessible.

How the Rate Adjusts

A 2:1 buydown reduces the effective interest rate by 2% for the first year and by 1% for the second year. After two years, the rate reverts to the permanent, agreed-upon interest rate for the remainder of the loan term. While the borrower’s payment is lower, the underlying mortgage interest rate does not permanently change; funds subsidize the payment as if the rate were reduced.

For example, on a 30-year fixed-rate mortgage at a permanent rate of 7%, a 2:1 buydown means the effective rate for payment calculation is 5% in the first year (7% – 2%). In the second year, the effective rate is 6% (7% – 1%). From the third year onward, payments are based on the full 7% interest rate. This temporary reduction provides financial relief as new homeowners settle in.

This results in a graduated payment schedule. For instance, on a $300,000, 30-year mortgage with a 7% permanent rate, the monthly principal and interest payment is around $1,610 in the first year (at 5% effective rate). It increases to $1,799 in the second year (at 6% effective rate). From the third year onward, the payment rises to about $1,996 based on the full 7% rate. These figures do not include property taxes or insurance, which also influence the total monthly housing cost.

Who Funds the Buydown

The financial backing for a 2:1 buydown typically comes from a third party, most commonly the home seller or a home builder. They offer it as an incentive to attract buyers, especially in markets where homes might be harder to sell. While buyers can sometimes pay for it, sellers or builders are frequent sources of these funds.

The funds for the temporary interest rate reduction are usually placed into an escrow account by the party funding the buydown at closing. This lump sum covers the difference between the reduced payment and the full payment over the two-year period. Each month, funds are drawn from this escrow account to supplement the borrower’s payment. This ensures the lender receives the full payment due at the permanent interest rate, while the borrower benefits from the temporary reduction.

Borrower Qualification and Repayment

Borrowers pursuing a 2:1 buydown must qualify for the mortgage based on their ability to afford the permanent interest rate, not the temporarily reduced rates. Lenders assess a borrower’s income, credit score, and debt-to-income ratio against the full rate to ensure long-term affordability. For instance, if the permanent rate is 7%, the borrower must demonstrate the financial capacity to make payments at that 7% rate, even though initial payments will be lower.

After the two-year buydown period concludes, the borrower’s monthly payments automatically increase to reflect the full, permanent interest rate that was initially agreed upon. The payment remains consistent for the remainder of the loan term, assuming a fixed-rate mortgage. Understanding this payment escalation is important for financial planning.

If the loan is refinanced or the property is sold before the two-year buydown period ends, any remaining funds in the escrow account are typically credited to the borrower. These unused funds may be applied towards the loan principal, effectively reducing the outstanding balance, or returned to the borrower, depending on the buydown agreement terms. This provision offers flexibility if circumstances change during the temporary buydown period.