I recently had a conversation with someone about 2-1 buydowns and lender points. I thought this would be a good article topic.
Andy Sabo (Loan Officer): Hey! I understand you're considering offering a credit for a 2-1 buydown to potential buyers. Let's go over what a 2-1 buydown is, how it compares to paying lender discount points, and how it might be beneficial in the current economic conditions.
Client: That sounds great. What exactly is a 2-1 buydown?
Andy: A 2-1 buydown is a mortgage financing option where you provide funds to lower the interest rate for the first two years. For the first year, the interest rate is reduced by 2 percentage points, and for the second year, it's reduced by 1 percentage point. After that, the rate returns to the original fixed rate for the remainder of the loan term.
Client: How does this differ from paying lender discount points?
Andy: Paying lender discount points involves paying upfront to permanently lower the interest rate over the life of the loan. Typically, one point costs 1% of the loan amount and reduces the rate by about 0.25%. In contrast, a 2-1 buydown provides a temporary reduction in the interest rate, easing the financial burden initially without a long-term commitment.
Client: When might a buydown be preferred over paying discount points?
Andy: A 2-1 buydown is often preferred when you need short-term affordability, expect your income to increase soon, or want to make your offer more attractive without reducing the sale price. It’s particularly useful in a buyer’s market or when you prefer to keep more cash available upfront.
Client: What if the economic conditions suggest that rates will drop by the end of the first year?
Andy: If rates are likely to drop, a 2-1 buydown becomes even more attractive. You benefit from lower payments initially and can refinance when rates drop, securing a new, lower rate before the original rate resumes. This avoids the upfront cost of permanent discount points, which might not be necessary if refinancing occurs soon.
Client: How would a refinance after 6 months affect the buydown?
Andy: If you refinance after 6 months, the funds in the escrow account for the buydown period may still have unused amounts. These funds could be applied to the principal of the original loan before refinancing, or they might be forfeited depending on the agreement.
Typically, you will forfeit the unused buydown fees. The new loan's terms will be independent of the original buydown, and you should weigh the costs of refinancing against the benefits of securing a new, lower interest rate.
Client: That makes sense. It seems like the 2-1 buydown could be a good strategy, especially if rates are expected to fall.
Andy: Absolutely. It provides immediate relief and positions you to take advantage of future rate reductions without a significant upfront investment in discount points. If you have any more questions or need further assistance, feel free to ask!
Client: Thanks, Andy. This has been very helpful.
Andy: You're welcome! I'm glad I could help.
