Ring, ring, ring. My house has been on the market for awhile and my agent has suggested that we offer a 2-1 buydown as a sales incentive. Is this a good strategy? Is it safe? I don’t want to offer one of those variable subprime loans which will jump sky high at the end of two years. 

A 2-1 buydown is an excellent marketing tool and offers great savings to the buyer which will extend over a two year period. And no, it is not like a subprime loan. The rate will increase to a predetermined fixed rate at the end of two years and stay at the rate for the entire life of the loan. It is a 30 year fixed rate loan which has been discounted for the first two years. 

When a house is not selling there are a number of strategies which are usually thought of. Often the first reaction is to lower the selling price. This will affect the mortgage payment slightly but the bottom line at the closing table will remain pretty much the same. Another strategy, especially for buyers with little cash, is for the seller to pay the buyer’s closing costs. Unlike a reduction in the sales price, buyers will see the savings immediately at the closing table with a dollar for dollar reduction in the bottom line. 

A 2-1 buydown takes an entirely different approach and may be used in conjunction with other strategies. Instead of reducing the sales price or paying closing costs, the interest rate on the loan is reduced for a specific period of time. On a $200,000 loan, the payment during the first year drops from $1,199.10 to $954.83 with a drop in the rate of 2%. This represents a savings of $244.27 per month. The second year the interest rate drops 1% and there is a monthly savings of $125.46. During the third year and for all the remaining years of the loan, the rate is fixed at the note rate and will never change.

In this example the borrowers will save over $4,400 in mortgage payments during the first two years of their loan.  This strategy offers tremendous marketing advantages. If current fixed rates are at 6%, then a fixed rate mortgage of 4% can be advertised for the first year, 5% for the second year and 6% for the life of the loan. In certain markets this could be the factor which tips the scale.  

How is this done and what is the cost? The simple fact is that banks love this strategy because they are able to collect extra interest upfront. This is free money for them so they easily accommodate this request. The cost is approximately 2.2% of the loan amount and is paid by the seller at closing. The bank puts this money into a separate escrow account and subsidizes the monthly mortgage payment for the first two years.  In addition to the 2-1 buydown which is a temporary buydown for the first two years, there are other programs which will buy the rate down for three years or programs to buy the rate down permanently.  

Everyone comes out a winner with these strategies. The seller has sold the home with minimal cost, the buyer has a great deal on their mortgage with reduced payments and the comfort of knowing their rate is locked for 30 years, and  the bank has collected a little interest upfront. The goal is to work with your agent and lender to combine strategies and programs for the best marketing approach.  

David Field creates Sound Mortgage Solutions with Carolina Home Mortgage. He can be reached at 919-869-8204 or david@carolinahomemortgage.com