As interest rates increase, banks become more creative with their loan programs to entice borrowers. A two-one buydown mortgage is one of these loan programs that you might’ve seen advertised. In this post, we explore a two-one buydown mortgage, how it works, and whether it’s something you should consider when buying a home.
A two-one buydown mortgage is a type of financing where there is a lower interest rate on the mortgage for the first two years — before it rises to the permanent rate — in exchange for a fee that must be paid for by the seller.
Let’s say you’re purchasing a $400,000 home with a 30-year fixed mortgage at a 5% fixed rate. If you went with a two-one buydown mortgage, the bank would give you a 3% interest rate for the first 12 months, a 4% rate for the second twelve months, and then the regular 5% rate for the remainder of the 30 years.
This means that you would save $5,530.44 in the first year and $2,851.50 in the second year.
However, here’s the catch.
When you do a two-one buydown mortgage, there is a fee that must be paid to the bank equal to the amount of savings. In this case, that would be $8,381.95.
So, if there are no net savings, why would someone ever get a two-one buydown mortgage?
That’s a great question.
One such use is that it’s often used by sellers to entice potential buyers. A seller may tell a buyer that they’ll save money upfront that they can put to use in other ways. It can also allow buyers to afford a home they might not be able to otherwise.
However, there are pitfalls to this.
If the buyer’s income doesn’t rise in line with the increasing interest rates that can put them in a sticky situation. As well, even if a seller offers to cover the fee, often any savings are lost due to price adjustments by the seller. In that case, the net savings would only be perceived.
So, in the case of a two-one buydown mortgage, you are financing your own buydown. Essentially you are paying for a perceived value, the lower rate for those first two years, but there is no actual value to this program because you are shifting that financial burden into the future.
Generally, we don’t suggest you agree to a two-one buydown. But there are still some ways you can save.
They only have perceived value which you will be paying for in the long run. They might sound good at first, but when you dig a little deeper and run the numbers it makes more sense to put your money to better use elsewhere.
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