Mortgage Buy down

With home prices pushing lower and mortgage rates at or near historic lows it has become a buyer’s market in housing. Some sellers, notably builders, are offering some interesting incentives in order to induce a prospective buyer to enter into a sales contract. Some include various upgrades but perhaps the most interesting incentive is the 2-1 buy-down on the mortgage. A 2-1 buy-down on a mortgage is a deceptively simple and worthwhile idea but it does have both good and bad points.

The Points are the Point of a Buy-Down

In any kind of buy down one party puts of a sum of money in order to reduce the initial interest rate on the loan. In many cases it is the builder and in the case of a 2-1 buy-down this means that the builder has paid a premium to the lender so the lender can offer the first year of the mortgage at 2 points or 2 percent lower than the going mortgage interest rate and the second year at 1 percent under the going rate. At the end of the buy down period the rate returns to the regular terms and the mortgage payment goes up with each increase in the interest rate.

Good for the Homebuyer

The great thing about a 2-1 buy-down is that it lowers the first two years payments due to the lower interest rate. To put this in perspective, imagine that a buyer is getting a mortgage for $417,000 which is the nationwide conforming loan even if some areas have higher maximums. With an interest rate of 5% this works out to a monthly payment of $2238.55 excluding taxes and insurance.  With a 2-1 buy-down, this monthly payment is reduced to $1758.09 for the first 12 months and then rises in month 13 to $1987.67 until month 25 when it increases again to $2221.92 for the duration of the loan. Over the course of the loan the homebuyer will pay much less in interest than a person who gets a fixed rate mortgage.

Cause for Caution

As good as 2-1 buy-down is for the buyer there is still cause for concern. Part of the premise of a 2-1 buy-down is that the buyer’s income will increase enough to cover the increased mortgage payment. For those people who have jobs that get routine raises this can make buying a home much more affordable. For those who don’t get regular raises the increase in mortgage payment can involve significant financial discomfort.

Overall, a mortgage that has a 2-1 step buy-down is a good deal and is in many cases much better than an adjustable rate mortgage because the step increases are well known in advance as opposed to the unknown rate increases of an adjustable rate mortgage. Another great aspect of the adjustable rate mortgage is that it frees up cash to help with the expenses of making a new house a home.