2-1 Buydown or Redemption, the term, indicates to a type of mortgage product with a set of two initial temporary starting interest rates that gradually increase until a permanent interest rate is reached. The initial rate cuts are paid either by the borrower to assist to qualify for a mortgage or by a home builder to encourage them to purchase a home.
Look at a glance
—A 2-1 Buy-out is a type of financing that lowers the interest rate on a mortgage for the first two years before it hits a sustained rate.
—Sellers and builders can offer purchase options to make a property more attractive to buyers by making payments to the lender during the first phase to subsidize the difference.
—In the case of a 2-1 buy-down, the price is reduced by two points in the first year, by one point in the second year, then reverts to the price charged after the end of the buy-down period.
How 2-1 Buy–down Works
A buyout is a form of financing that makes it much easier for a borrower to qualify for a lower interest rate mortgage. In return, the seller or the builder pays the lender an interest rate reduction during the first years of the mortgage in the case of temporary redemptions or for the entire duration of the loan in the case of permanent redemptions. Sellers and builders can offer these options to make a property more attractive to buyers. This effectively means that the buyer gets a discount on their mortgage.
2-1 redemptions are considered temporary redemptions. With this type of mortgage, the interest rate is reduced for the first two years of the mortgage. For example, a mortgagor who negotiates a 5% interest rate on his $250,000 property can effectively reduce his interest rate for the first two years with a 2-1 buyout – to 3% for the first year and 4% for the second year.
After the expiration of the two-year term, the interest rate for the remainder of the mortgage increases again to 5%. Payments from the seller or builder help subsidize the difference that is paid to the lender.
A 2: 1 buyback gives the borrower the opportunity to strengthen their finances to better cover mortgage payments. It also allows them to buy a home at a higher price than they could normally afford. Part of the assumption is that the borrower’s salary increases during this time, giving them more leeway for the remaining term of the mortgage.
Choosing such a buyback based on expected income increases may run the risk that the borrower’s household income will not increase at the expected rate. If the borrower does not see an increase in income to the same extent as the payments due after the repurchase expires, he could suffer losses.
The cost of a buyback is an upfront payment to reduce monthly mortgage payments. It is sometimes calculated and placed in an escrow account which is paid each month a certain amount equal to the difference of the temporary mortgage payment. At other times, the cost of redemption is treated as a traditional mortgage item.
While it may sound appealing, all borrowers should do a thorough analysis to make sure that a buyback is economical in any situation. This is because some sellers and / or builders may increase the purchase price to compensate for the difference in costs- especially under certain market conditions.
Some state and federal mortgage programs may not have any buybacks available. The 2-1 buyback is only available on Federal Housing Administration (FHA) fixed rate loans and only on new mortgages. Therefore, adjustments or refinancing of existing mortgages will not be eligible, and terms and conditions may vary by lender.
For example, a borrower who has an FHA loan could make a buyout payment to lower the monthly mortgage for two years on a 15- or 30-year loan if a 2-1 Buyout option is available. After the expiration of the purchase period, the borrower must make full monthly payments for the remaining 28 years of the term.