A “buydown” mortgage involves an initial reduction in the interest rate of the mortgage, usually for a specific period. With a loan amount of $400,000, this translates to nearly $500 a month in savings (depending on prevailing rates and length of your loan). There are two common types: a permanent buydown and a temporary or 2-1 buydown. Let’s compare the advantages of a 30-year mortgage with a permanent interest rate buydown versus a 30-year mortgage with a 2-1 buydown.
Permanent Interest Rate Buydown:
In a permanent buydown, the interest rate is lowered by a certain percentage for the entire duration of the mortgage. In many cases, the interest rate would be permanently reduced by as much as 2%. This offers the following advantages:
- Easier Qualifying: When qualifying for a 30-year mortgage with a permanent buydown, your debt to income ratio will be calculated using the lower interest rate. In a 2-1 Buydown, you typically have to qualify at the higher long-term interest rate for the majority of your mortgage payments. Without a permanent buydown, you may need to show as much as $15,000 in additional income per year to qualify to buy your dream home.
- Stable Payments: Your monthly payments will be lower and stable over the life of the loan. This can provide better budgeting and financial planning as you won’t face the risk of payment shock due to interest rate increases.
- Long-Term Savings: Over the course of a 30-year loan, a permanent interest rate reduction can lead to significant interest savings compared to a loan without a buydown. Anywhere from $20k up to $150k in savings depending on prevailing rates!
- Predictable Interest Savings: You’ll know exactly how much you’re saving on interest throughout the loan’s term. This can help you evaluate the true cost of the loan and understand your financial benefits.
In a 2-1 buydown, the interest rate is reduced for the first two years and then increases in the third year to a rate that remains for the rest of the loan term. These vary slightly from lender to lender in that some start at a low rate, then add 1% at the end of the first year, then add another 1% at the end of the second year. Others are fixed for 24 months, then raised to their permanent rate for the remainder of the mortgage term.
The advantages of a 2-1 buydown are slightly different:
- Lower Up Front Fees: A temporary buydown cost less up front than a permanent buydown. For those with a seller helping to pay closing costs, this can be a great way to utilize seller concessions.
- Initial Affordability: In the initial years, you will have lower monthly payments compared to a standard fixed-rate mortgage. This can help if you expect your income to increase in the future or if you’re looking for lower payments during a specific period (e.g., while you’re still settling into the new home). For those relocating with a “trailing spouse”, this initial lower payment can offset lower income while your spouse looks for employment.
- Flexibility: A 2-1 buydown gives you flexibility in the first two years when you might have other expenses related to moving, furnishing, or home improvements. After the third year, your payments become more predictable.
- Interest Savings in Early Years: You’ll save more on interest in the first two years compared to a standard mortgage, which can be advantageous if you plan to refinance or sell the property within that time frame.
- Easily Refinanced: Rate/term reduction refinances of this type of mortgage are typically non-qualifying (as long as you don’t attempt to cash out your equity), and the long term loan can be rolled over to a permanent lower interest rate loan should rates drop in the future. It’s the perfect way to “Date the rate, but marry the Home”.
Ultimately, the choice between a permanent interest rate buydown and a 2-1 buydown depends on your financial situation and goals. If you value long-term stability and savings, the permanent buydown might be more suitable. On the other hand, if you’re looking for initial affordability and flexibility, the 2-1 buydown could be a better fit if you have to pay for the buydown yourself, or have limited seller concessions to help cover the costs. The initial rate may be a little lower than the permanent buydown, making this an attractive option for those in need of more wiggle room on initial payments.
Currently Kerley Family Homes, in conjunction with KFH Mortgage LLC, is offering a great chance to get into your dream home with lower interest rates that are not only permanently reduced versus a 2-1 buydown, they’re more than competitive with today’s mortgage market. The best part is, these lower rates are available at no cost to you! As a part of our Unlock Your Dream Home promotion, we’ll secure financing for you at a rate as low as 5.5%(6.625APR)†.