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The 2-1 Buydown Strategy
March 2, 2023
The 2-1 Buydown Strategy
2:1 Buydown Strategy is Marketed a lot –
but it is a Good Idea?
but it is a Good Idea?
A “2:1 buydown strategy” is marketed heavily as a way to lower payments for a homebuyer since interest rates have jumped up. It can help sellers market their property and attract a buyer. It can help a buyer with lower payments in the first one, two or three years of the loan. However, it comes with a cost and it is important to understand that impact – and decide for yourself if the strategy make sense to you compared to how those same funds can be utilized. I am Clay Selland from Signet Mortgage and for the next few minutes I will cover the good and bad with the buy down strategy.
A 2:1 buydown means that someone prepays the interest on a loan transaction calculated as2% for the first year and 1% for the second year. Let’s take an example with a $750,000 purchase with a $600,000 loan. The prepaid interest is about $15,000. To a buyer, It appears very attractive because in the case of a 2:1 buydown, the payment calculated as if the interest rate was two points lower than the actual note rate for the first year and 1% lower than the note rate for the second year. The loan reverts to the note rate after year two.
Sounds really good so far. In our example the monthly payment savings in the first year is over $700 and almost $400 in the second year. However, remember that somebody pays.
Let’s look a little closer.
Let’s say the seller covers the cost by offering a credit towards closing costs. The net to the seller is lower by that credit. All other things being equal you would expect the seller would be willing to lower the purchase price by a corresponding amount.
The buyer gets lower payments for year one and year two. They buyer paid more for the home than the seller would be willing to accept. The same credit from the seller could be used to lower the purchase price or do a permanent buydown of the interest rate.
There is one instance where you might as well take the buydown. Homebuilders are particularly interested in the buydown because the published sale price of the homes they have for sale appear higher because they do not have to show the big credits that are offered to buyer. It is a way to offer a discount to a buyer that does not impact the list price of the home. That is also why builders toss in free upgrades and stuff.
Buyer covers cost – well that’s just silly because the extra closing cost to cover the interest in year one and year to is simply prepaid interest and would be better off leaving that money in your checking account to cover the extra payments. There is no benefit to qualifying for the
loan as qualifying is based on the fully amortized payment – not the reduced payments in the first and second year.
loan as qualifying is based on the fully amortized payment – not the reduced payments in the first and second year.
Let’s look at alternatives a buyer can use that “seller credit” – Use same $$ as a price reduction. That would save a small amount on property taxes as the basis in the home would be less. Also, the down payment and loan could be smaller, and the monthly payment produced by corresponding amount.
Better yet, use same $$ to pay points and buy down rate for the entire term of the loan. The benefit is only for the time period the buyer expects to hold the loan but still can be more valuable. The permanent buydown is a big deal! In our example the rate would be 0.625% lower if the funds were used to permanently buydown the rate. Compare this … do you want to permanently lower your payment by $578 (in the
example) or the $700 for year one and $400 in year two ONLY. One more benefit. If you’re on the edge qualifying this permanent buydown could be the difference getting your loan approved.
I would not jump on the bandwagon to get a 2:1 buydown or even 3:2:1: buydown I saw advertised by one of our wholesale lenders today.
Quick summary …
A seller can aggressively market their home by offering a 2:1 buydown. It certainly can look attractive to a buyer and at less cost to the seller when compared to lowering the purchase price.
As a buyer, If you are buying a home from a builder they are not likely to be flexible on the price of the home but you can negotiate credits that have a similar affect. Then you have to decide how to use the credit 2:1 buydown of the payment temporarily OR permanent reduction in the interest rate
If you are buying from private party, you have these same choices. Sometimes an offer sounds more attractive to a seller if it’s a full price offer and you ask for a credit that you can use for a temporary or permanent buydown in the interest rate. Alternatively, you could just negotiate a reduction in the purchase price of the home
Keep in mind that you have to qualify on the full payment anyhow so a temporary buydown does not help you qualify as a permanent buydown could indeed help. All the hype around a 2:1 buydown is a sales tactic. You need to work with someone who gives you a real apples to apples comparison so you can make the best choice for you and your family for the long term.
If there is anything I can do to help you understand and leverage a buydown strategy, please give me a call. My information is listed below. I look forward to working with you!
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