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Soaring interest rates over the last year and variations this year have many potential homeowners turning to mortgage buydowns to make owning a home more accessible—but can you refinance a 2-1 buydown?
A 2-1 buydown sets an initial higher payment but pairs it with a lower interest rate during the initial two years of the mortgage.
Managed correctly, it could save a borrower thousands of dollars over the lifetime of a 30-year fixed-rate home loan.
If you are searching for ways to save more money on your new mortgage, you should be aware of the rules of these loans and—more importantly—whether you can refinance a 2-1 buydown. Here’s what you need to know about 2-1 buydowns and refinancing them.
What is a 2-1 buydown mortgage?
A 2-1 buydown is an ARM-type of loan in which you can access a lower rate for the first two years of the home loan. During this period, the borrower pays a lower monthly payment compared to what most lenders typically offer.
After two years, the interest rate increases to a higher level agreed to in the original agreement. Theoretically, it will stay at this new, higher level until the loan is paid in full.
In some cases, the agreement may be a 3/2 or 5/1 buydown, in which the rate is reduced for three or five years, respectively.
For most 2/1 buydown programs, the first year of the program reduces the rate by two percent and in the second year by one percent. At the start of the third year, the full rate resumes.
Borrowers often have the option of paying a lump sum into an escrow account with the lender or setting up a mortgage points agreement.
Predicting interest rates
Even though mortgage rates are declining slowly, they are still quite high compared to 2021.
Those who purchased a home two years ago know that the third year is coming soon. These borrowers also know they must be able to handle the new mortgage payments once the interest rate reverts to its original level.
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What are the costs of a 2-1 buydown?
During the initial two years of a 2-1 buydown, you can realize considerable savings on your monthly payments—frequently adding up to thousands of dollars.
There may be a required upfront fee placed into an escrow account, although that might vary based on the loan amount and the lender (it’s also possible to avoid this fee altogether in some cases).
Pros and cons of 2-1 buydown
A 2-1 buydown provides a great opportunity to lower one’s monthly payments, but there are other benefits (as well as drawbacks) associated with this type of financial arrangement.
Benefits of a 2-1 buydown
Many new homeowners are not accustomed to the financial and physical responsibilities of homeownership. This inexperience is why a more affordable month-to-month bill may give some a more gradual starting period.
A 2-1 buydown also enables access to more disposable income for the initial period. New homes will always have hidden or unforeseen costs—repairs, utilities, and upgrades, to name a few.
More manageable monthly payments could also mean you can afford a bigger mortgage or a better house.
Finally, if refinancing is approved within the first two years, the unused portion of the 2-1 concessions are often applied toward the principal. The unused funds decrease the mortgage debt by basically acting as a principal payment.
Drawbacks of a 2-1 buydown
A 2-1 buydown mortgage option has a higher initial cost unless the seller is covering the cost. Plus, if the escrow holder runs into difficulties and doesn’t forward the payment, you are responsible for it.
And last—but certainly not least—the borrower must be able to cope with the much higher payments once the third year starts. If not, their new home is in jeopardy.
Refinancing options for 2-1 buydown mortgages
As shown above, 2-1 buydown mortgages are viable options for short-term benefits when the rates are particularly high. This temporary solution allows borrowers a more affordable break while waiting for better rates before opting for a refinance.
Benefits of refinancing a 2-1 buydown mortgage
Refinancing your home loan can be an effective way to access more favorable repayment terms.
You could also save thousands of dollars on your loan, reduce your monthly payments, and give more flexibility to your budget.
Some of the main benefits of refinancing include the following.
Lower interest rates
Refinancing your home loan can help you save money by reducing your interest rate. Even a small lowering of your interest rate could lead to substantial savings over the life of the loan.
Lower interest rates would also immediately reduce your monthly payments, freeing up your funds for other purposes.
Longer loan term
Refinancing could also allow you to extend the term of your loan, thereby reducing your monthly payments in an additional way.
Access to home equity
If you’ve already managed to make significant payments, refinancing your mortgage can also provide access to the equity in your home.
With access to this equity, you can use it to make home improvements, pay for college tuition, or even pay off other debt. Refinancing is frequently used as a way to consolidate debt and improve a person’s financial situation.
Refinancing a 2-1 buydown—the bottom line
It’s possible to refinance a 2-1 buydown mortgage, depending on the agreement you signed with the original lender.
While interest rates have generally been going in the right direction since the end of 2022, no one can predict how long the trend will continue.
A sudden rise in monthly payments might cost you more now (with higher mortgage payments) and in the future (the overall loan cost).
Refinancing has the potential to lower your monthly payments through a combination of a lower interest rate and a longer loan term. For those who have paid off a significant portion of their home, it can also enable them to gain access to that equity.
If your 2-1 mortgage is about to enter the third year, get started with a free conversation with one of our experienced loan officers at Homefinity about the possible benefits of a refinance.