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2-1 Buy-Down Can Make House Payments Affordable for Buyers
by Matt Difanis
February 2001

You may have heard or read that it is usually possible to pay points at closing (a point is equal to 1% of your mortgage amount) to lower your mortgage interest rate for the entire life of the loan. I generally do not recommend this to clients, as buyers would have to stay in the house for the entire life of the loan to reap the full benefits of the lower rate provided by paying points. A 2-1 buy-down can provide the benefits of points without the typical drawback. With a 2-1 buy-down, about 2.25 points are paid upfront, but the benefits are all concentrated into the first two years of the mortgage as follows:

In the first year of a typical 30-year mortgage, the interest rate is lowered by 2% points. For example a 30-year mortgage at a rate of 7.25% would only be 5.25% for the first year.
In the second year, the rate has a 1% discount, so the above example loan would have a rate of 6.25% during the second year.
For years 3-30, the rate is the market rate of the original loan (e.g., the 7.25%)

Hopefully, the "2-1" name makes more sense now. :-)

It is important to realize that the drawbacks to this technique are the upfront points and the guarantee that your rate will go up after the first and second years of ownership. Either the buyer or the seller can pay those points to pay for the interest rate buy-down; however, on a $150,000 house with a 95% mortgage, each point costs $1,558. With a 95% mortgage on a $150,000 house, a 2/1 buy-down would cost about $3,200. If a buyer wants the seller to pay for those points at closing, then that becomes one part of the overall negotiations, just like price and closing date. To entice sellers into paying those points, buyers may opt to pay slightly more than the list price in exchange for the sellers agreeing to pay the 2.25 points at closing. If you agree to a somewhat higher purchase price to make up for a seller paying points, then you will end up with a slightly larger mortgage amount and slightly higher payments after the buy-down period ends.

The following is a general description of buyers who are well suited for this sort of scenario:

People who currently have an income that limits their buying power, but who know that their income will definitely rise within two years
Households where one of more members of the family is in college or grad school, and where those individuals will be finished within two years
Households with student loans or other large debt payments that will be paid off within two years

My last clients who did this fell within the first category. The woman worked full-time, but the husband was training for a new job. Because of his training, the husband's income was limited and he had major training expenses. The 2-1 buy-down gave them a significantly reduced payment during those first two years when they needed it. When their mortgage returned to its permanent rate, he was out of school and working full-time.

The contents of this article are for information purposes only, and the specific scenarios are for example purposes only. I am not making any specific recommendations. Remember, regardless of how large a loan a bank will give you, it is important that you determine that you stay within what works comfortably for your own budget.

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