A 2-1 Buydown or two-step mortgage combines fixed rate financing with a lower start rate for the first 2 years of the loan without negative amortization. For example, you may be able to obtain a 2-1 buydown at a final rate of 6.5% for years 3-30. The first year interest rate for this program would 4.5%, the 2nd year rate 5.5%, and years 3-30 6.5%.
This is done by pre-paying the first 2 years interest at closing. For purchases, many times the seller can fund the buydown in the form of a seller concession. Many mortgage brokers and lenders also offer lender funded buydowns as well for both purchases and refinances. Be sure to consult with your mortgage profession for your buydown options.
When purchasing a home, a buyer can request a seller concession that will fund a buydown. A builder may also be willing to fund a 2-1 buydown for new construction as well.
The 2-1 buydown fee is prepaid interest and as such may be tax deductible. On a purchase in particular this can be a great tax benefit in your first year of a purchase. Consult your tax advisor for details.
A 2-1 buydown is a great way to help a first time homebuyer qualify for a loan. Many first time homebuyers are young couples or families with an increasing salary base. This program gives temporary relief from a high payment and gives the new homeowner time to stabilize their finances allowing for salary increases, second household incomes, etc.
One of the main advantages of a 2-1 buydown mortgage over alternative such as Graduated Payment Mortgages and Option ARMs is that there is no negative amortization or deferral of interest in most cases. This is because a 2-1 buydown mortgage, and other buydown mortgages, has a buydown account which is funded (either by yourself or the lender) to cover the balance of the interest on the loan during the first 2 years until you begin making full payments in the 3rd year.
Another benefit of a 2-1 buydown for young couples is that it allows you to concentrate on paying off smaller debts for 2 years as your payment gradually increases.