Release Date:
January 11, 2023
What Is a 2-1 Buydown and How Does It Benefit Homebuyers?
Featuring:
Mortgage Professional Mike Swaleh
A 2-1 buydown can help make homeownership affordable even when interest rates are rising.
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A 2-1 buydown can help make homeownership affordable even when interest rates are rising.
Introduction: Welcome to the Homeownership Insights Podcast, your leading mortgage podcast, sponsored by Fairway Independent Mortgage Corporation. Listen as experts from across the country share knowledge to help homebuyers and homeowners make the best decisions in their homeownership journey. Our next podcast begins right now.
Casey Morris: Welcome back to the Homeownership Insights Podcast. I'm Casey Morris, and today I'm talking with Fairway area manager Mike Swaleh about 2-1 buydowns. Now, most homebuyers probably haven't heard of a 2-1 buydown and have no idea what that is. But that's why today's episode is going to be hopefully so enlightening for you because it's a great tool that you can use as a homebuyer heading into the new Year. So, Mike, thanks so much for being on today.
Mike Swaleh: My pleasure. Thanks for having me.
Casey Morris: Awesome. So let's just get right into it. So I was hoping that you can start us off by defining exactly what it is a 2-1 buydown is.
Mike Swaleh: I can absolutely do that. So, the 2-1buydown is a tool. It's a tool that can be used to solve a specific problem. So, it almost makes make sense for you to talk about the problem that it solves, more so than the facts and features of the of the tool itself, right?
You don't necessarily care how a rake is made. You just know that you have leaves that need to be scooped up. Right? So, the problem that the 2-1 buydown solves is hey, rates are high right now and that creates a really good time to buy a house because there's fewer competition for the existing inventory and sellers are more apt to negotiate right now. So how do I use the ability to negotiate with a seller potentially and really maximize the benefit to me?
And a lot of people believe that we're in a period that's not going to last forever and that rates will come down in the future. So, if I'm looking at a potential house that I want to buy and I want to solve the problem of, hey, rates are high right now, I think they're going to go down in the future, and I have a limited opportunity to negotiate and get the best deal on this house, what can I do?
That's where the 2-1 buydown comes in and helps you solve that problem by using seller concessions to give you an artificially low rate temporarily, which buys you time to potentially refinance into a low rate permanently. If you are correct in that rates come down in the future, at the very least, if you're not correct and rates don't come down in the future, then at least you enjoy an artificially low rate for the period of time that you get to enjoy it. Does that, is that clear?
Casey Morris: Yeah, that makes sense. So, for homebuyers who are listening to this, how exactly would that work? What exactly are they asking of the seller when they're talking about a 2-1 buydown?
Mike Swaleh: Great question. So, what they're asking is for a seller credit that they're going to use for a specific purpose. So, if you are a seller trying to make your property more attractive to a buyer, you really have, you know, several different tools at your disposal. Offering a credit for the 2-1 buydown is one of those tools. You might also or, you know, alternatively offer a price reduction. You might alternatively offer a seller credit that you're marketing towards buying down their interest rate permanently or using it for closing costs.
The 2-1 buydown is a specific program where you take an amount of those credits and you create an escrow account. Those credits go into an escrow account, and that escrow account subsidizes your mortgage payments for the two years that you have the buydown, 2% in the first year, 1% in the second year.
So, a lot of people think you're buying down your interest rate and you're not actually directly buying down your interest rate. What you're doing is you're creating an escrow account to subsidize your payments so that the payment that the borrower actually makes is equivalent to what the payment would have been had the rate been 2% lower in the first year and 1%lower on the second year.
One of the reasons that's an important distinction is thatwhen you buy down a rate permanently, that money becomes a sunk cost. You'vespent it already. But with a 2-1 buydown, because you're not technically buyingdown the rate because you're opening that escrow account, the money is stillthere for you and the unused portion you get to retain if you refinance or sellthe house in the future. And so that's a key distinction of the way that works.
Casey Morris: Okay. So how would the buyer access those funds if, say, their seller agreed to a 2-1 buydown? And then at the end of this year, rates drops to you know, let's say they were actually 2% lower so they wanted to refinance. How would they access those funds? Would that just be applied to their mortgage balance or do they actually get that as cash?
Mike Swaleh: That's exactly right. It gets applied to their mortgage balance. So, whatever is left in that escrow account gets applied to the principal of the loan at closing. So, when you go to refinance, your principal is less. And depending on that current appraised value or property inspection waiver or however we are valuing the property at the time of refinance, lowering that principal balance might just give you room to be able to roll in the closing costs of the refinance. So, a lot of people are marketing it as, hey, you can use it to pay your closing costs. And that's not technically true, but effectively it could be.
Casey Morris: Okay. Gotcha. Gotcha. And for somebodywho is listening to this and they're thinking, okay, sure, I can do this now,or, you know, there's speculation that rates are going to drop in the next sixmonths to a year. Why would I not just wait and see if that happens versustrying to negotiate with a seller now and take the higher interest rate? Youknow, I may end up with a longer with a higher interest rate long term. So, youknow, how would you sort of explain the benefit of still making that move nowversus waiting and seeing if rates drop?
Mike Swaleh: Yeah, I've heard a lot of that. It's agreat question because I've heard so many potential buyers echo that and saythe same thing. And a lot of buyers are feeling that way. They're feeling like,why don't I just wait till rates come down? And what we're finding is thatthat's a very ironic sentiment for the exact reason that everybody's thinkingthat. Right?
So, if you follow that through the very thing that we'retalking about, the 2-1 buydown isn't going to be likely available then becauseit relies heavily on being in a position to negotiate with that seller. And ifall of a sudden, all of the people that feel like you do that rates are goingto go down, and why don't they just wait? If they all come back to the marketwhen rates do go down, now you have more competition for the same amount oflistings and your ability to negotiate is diminished. And so, a key componentis being able to negotiate with the seller, which then gets lost if rates godown potentially.
Casey Morris: Okay. That makes sense. And of course, there's no guarantee that rates are going to come down. You know, nobody can say with certainty what's going to happen. So, if you wait and hope for that and then it doesn't happen, then you're still, you know, and then if everyone has waited and is getting back into the market, then you've kind of lost your leverage in that way as well. So, you're still paying a higher rate, but the seller has less incentive to work with you.
Mike Swaleh: That's exactly right. A good way to look at it as there are three things that can happen, right? We can all make all the predictions we want, but inevitably, one of three things is going to happen.
Either rates are going to go up and whatever rate you got today is going to end up looking really good because rates went up, right? Or rates can stay the same. In that case, you haven't lost anything because the rate that you got is the rate that you would have got. You just moved before everybody else did and were able to snag a potentially better deal than everybody else, or rates go down and then your competition goes up. You have to pay more for the house.
And if you already own the house because you used a tool like the 2-1 buydown, you acquired already, you still get to refinance into that lower rate in the future. The difference is everybody else is out there competing for limited inventory and nobody's competing for your house anymore because you already own it.
So, of those three things, again, that, you know, in order to understand the tool, you have to understand the problem that it's fixing. It's helping make sure that you put yourself in the best position possible no matter what happens.
Casey Morris: Yeah. And are there any drawbacks for homebuyers with the 2-1 buydown, or is it just basically a win-win?
Mike Swaleh: It's a win-win. The not necessarily a drawback, but one of the key assumptions is that you're able to negotiate the seller's credit, right? So that it's not sort of a drawback. But one of the risks is what if you can't negotiate that credit? What happens then? You are, under certain programs, able to do a 2-1 buydown buyer paid, and there are varying opinions on that.
I'm not, I personally I don't recommend that because it's, you're just moving money from one hand to the other and it doesn't do you any good, in my opinion. It is important to understand, though, that from a financial impact perspective, that same credit used towards a 2-1 buydown is more beneficial financially to you in both the short and long run than a price reduction in the house. So, it's, it solves kind of that intermediate need without necessarily having a big drawback that I can think of.
Casey Morris: Okay. And it's more advantageous to do the 2-1 buydown than to get a price reduction on the house because with the price reduction, you're paying less for the house upfront, but you're still paying that higher interest rate the entire time. Is that correct?
Mike Swaleh: Yeah. Yeah, there are, you know, in thiscase, there are a lot of different things that can happen over time. And one ofthe arguments that people use when they're analyzing different products,because in the truth is everybody's situation is different and should be lookedat on an individual basis.
So, any time we're speaking in generalities, there's goingto be a certain subset of the population that says, well, wait a minute, andnot in this case, and they're going to be right. Right? But people tend tothink, well, if I own the home forever, right? If I own the home for my entirelife, the price reduction is better. Right? And my argument to that is you gotto separate owning the home from having the mortgage, because we, you know,hopefully if you think about owning the home forever, that doesn't necessarilymean you're going to have the same mortgage forever. Right?
So, you if you get the 2-1 buydown versus the pricereduction, there's sort of a gradient where there are certain periods of timewhere one is better than the other. But the 2-1 buydown is sort of a temporarysolution that puts you in a really good position to win over the long term.
So, are there situations where the price reduction may bebetter? There could be. It depends. It depends on how much price reductionwe're talking about. Right? One of the really great things about a 2-1 buydownis that it gives you more dollar for dollar impact on the buyer. So, it maymake your payment lower than a price reduction that's double the size and youmight not have been able to get that price reduction from the seller, but youcould get the 2-1 buydown. So, there is some analysis and comparison thatshould go into anybody's individual financial situation. But if we're speakinggenerally, you have a much better shot at getting yourself in the bestfinancial position with the 2-1 buydown versus price reduction.
Casey Morris: Okay. So just to kind of summarize thebenefit, the best-case scenario is that if someone were buying a house in thenext couple of months and their seller agreed to a 2-1 buydown, functionallythey're basically paying a, you know, for what it looks like for them on paper.Functionally, they're looking at the first year their interest rate is 2% lowerthan it would have been, the second year it's 1% lower than it would have been.But ideally, in that time, rates will also come down. And so, they're neveractually going to end up paying the higher interest rate because before the 2-1buydown period is over, they'll be able to refinance to the lower rate andthey'll be paying less for the entire life of their loan.
Mike Swaleh: That's the ideal scenario.
Casey Morris: Okay. Okay, great. And do you have any tips for how homebuyers can introduce this conversation to sellers? Any negotiating tactics or ways to kind of persuade them to work with them on this?
Mike Swaleh: Yeah, you know, there's really two. Two different benefits to the two. And by now there's the benefits that it actually presents to the buyer. But then there's a marketing benefit if you are a seller. So, I would argue that sellers should be convincing buyers to take it,not necessarily the other way around. Right? Because you're using that to sell a property. And if you had to offer it, it means that your property didn't sell on the first day for over asking like people are used to. Right? So, I almost think it's more important as a marketing tool for sellers to help get buyers into their properties.
But if you are a buyer and you're looking at this, how I think the most important benefit you can relate to the seller that convinces them is, Hey, I'm going to get what I want and it's going to cost you less than reducing the price of the house to get me what I want. And so it's really a good way for a buyer to kind of get a middle ground on a negotiation.
And I think the best thing that they can do is not try to explain this themselves and to refer them to us as their lender, to fully describe the situation and let them know all the cost, benefits, caveats, disclaimers. And let us drive that conversation, because I think I speak on behalf of all our loan officers when I say we'd be happy to do that for you.
Disclaimers:
Mike Swaleh
NMLS #739145
For a Conventional loan, the seller or buyer can pay for the buydown. For VA, FHA,USDA and Jumbo loans, only the seller can pay for the buydown.
The information in this podcast is distributed for educational purposes only. The information is not guaranteed to be accurate and may not entirely represent the opinions of Fairway Independent Mortgage Corporation.
Copyright©2022Fairway Independent Mortgage Corporation. NMLS#2289. 4750 S. Biltmore Lane, Madison, WI 53718, 1-866-912-4800. All rights reserved. Fairway is not affiliated with any government agencies. This is not an offer to enter into an agreement. Not all customers will qualify. Information, rates and programs are subject to change without notice. All products are subject to credit and property approval. Other restrictions and limitations may apply. Equal Housing Opportunity.
Fairway is required to disclose the following license information. AZ License#BK-0904162; Licensed by the Department of Financial Protection and Innovation under the California Residential Mortgage Lending Act, License No 41DBO-78367.Licensed by the Department of Financial Protection and Innovation under the California Financing Law, NMLS #2289. Loans made or arranged pursuant to a California Residential Mortgage Lending Act License; Georgia Residential Mortgage Licensee #21158; For licensing information, go to www.nmlsconsumeraccess.org; MA Mortgage Broker and Lender License #MC2289; Licensed Nevada Mortgage Lender; Licensed by the NJ Department of Banking and Insurance; Licensed Mortgage Banker-NYS Department of Financial Services; Rhode Island Licensed Broker & Lender; Fairway Independent Mortgage Corporation NMLS ID #2289 (www.nmlsconsumeraccess.org).
The information in this podcast is distributed for educational purposes only. The information is not guaranteed to be accurate and may not entirely represent the opinions of Fairway Independent Mortgage Corporation.
Copyright©2022 Fairway Independent Mortgage Corporation. NMLS#2289. 4750 S. Biltmore Lane, Madison, WI 53718, 1-866-912-4800. All rights reserved. Fairway is not affiliated with any government agencies. This is not an offer to enter into an agreement. Not all customers will qualify. Information, rates and programs are subject to change without notice. All products are subject to credit and property approval. Other restrictions and limitations may apply. Equal Housing Opportunity.
Fairway is required to disclose the following license information. AZ License #BK-0904162; Licensed by the Department of Financial Protection and Innovation under the California Residential Mortgage Lending Act, License No 41DBO-78367. Licensed by the Department of Financial Protection and Innovation under the California Financing Law, NMLS #2289. Loans made or arranged pursuant to a California Residential Mortgage Lending Act License; Georgia Residential Mortgage Licensee #21158; For licensing information, go to www.nmlsconsumeraccess.org; MA Mortgage Broker and Lender License #MC2289; Licensed Nevada Mortgage Lender; Licensed by the NJ Department of Banking and Insurance; Licensed Mortgage Banker-NYS Department of Financial Services; Rhode Island Licensed Broker & Lender; Fairway Independent Mortgage Corporation NMLS ID #2289 (www.nmlsconsumeraccess.org).
