With higher interest rates, we’re getting questions regarding “buying down” the rate. Some people want to do a 2-1 buydown. What is this? How does this work? Is this the same as permanently buying down the rate for the life of the loan?
A 2-1 buydown is an example of a temporary buydown. In a 2-1 buydown, the interest rate is 2% lower in the first year, and 1% lower in the second year. If today’s rate is 7%, then the first year the rate would be 5%, and the second year the rate would be 6%. The lender, however, still receives payments at the 7% rate during these first 2 years. The difference in payment in the first 2 years between 5% and 7%, and 6% and 7%, is collected at closing and put into an escrow account. When you make your monthly payment at 5% in the first year, the balance of the payment is paid to the lender out of the escrow account. The temporary buydown is just that, it only temporarily buys down the rate for the specified time period, but a full payment is made to the lender at the Note rate (7% in the above example). The only way the temporary buydown benefits the borrower is if it is paid by someone else at closing, for example, the seller.
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