Are you in the market for a new home or thinking about refinancing your existing mortgage? If so, you may have heard about the 2-1 Loan Buy Down Program. Speaking from a realtor perspective I do really want to promote the heck out of this program to everyone however, when i put my investor hat one, one need to be paying attention to the detail.
Without fully understanding what it is and the bet that you are getting into. the 2-1 Buydown Loan could be a double edge sword. Here is my personal take:
Understanding the 2-1 Loan buy down Program
The 2-1 Loan Buy Down Program is a mortgage financing strategy that aims to provide the borrowers with a lower interest rate during the initial years of their loan say 2 year in this case hence the word 2-1 buy down. It is a smart solution for those who want to save money in the short term or qualify for a larger loan without increasing their monthly payments.
But what about the long term? are you prepare for year 3 if thing does not go as plan?
What is the 2-1 Loan buy down Program
The name “2-1” signifies the structure of the program. In the first two years of your loan, you’ll enjoy a reduced interest rate, often lower than the prevailing market rates. After these initial two years, your interest rate will increase slightly but still remain lower than what you’d typically receive with a standard fixed-rate mortgage.
This program allows you to benefit from the lower interest rate during a crucial period when you might be settling into your new home or managing other expenses related to the move. Additionally, the gradual increase in the interest rate after the initial two years ensures that the program remains cost-effective for borrowers over the long term.
Hence the word “Buy Down”, as a smart consumer or an investor. You have to immediately ask yourself: Who is BUYING? There is only several parties. Either the seller will buy, the lender will buy, the builder will buy, YOU will buy, or everyone will chip in and buy.
The way i personally think about it is you actually prepaid the interest for the 1st 2 year. the mortgage broker collect that in advance. When you think about it that way. all the sudden It not a deal any more. if you are the one paying. But if the lender is trully paying for it, and the word is trully, or you can get the seller to pay for it. Then the deal might work out.
- Lower Initial Payments: The reduced interest rate in the first two years can significantly lower your monthly mortgage payments, making homeownership more affordable during the initial period.
- Improved Cash Flow : Lower initial payments mean you’ll have more disposable income to invest in home improvements or save for future financial goals. Some people has a goal of only holding their investment in two years. Or you are making a bet that rent with appriciate in year 3+ and more. which is a safe bet given the inflation that we have right now this work perfectly.
- Rate Stability:You know exactly what the rate will be on year one year two and year tree. This offering stability and predictability in your monthly mortgage payments. It’s not like the rate will float with no rate lock like commercial loan
You are pretty much making a bet that in 3 years, you can afford a higher payment. Make sure you get that pay raise, the market will support the rent increase, or you will end up driving Uber, or selling an extra house or two to cover that increase in payment.
The bet that people are making that interest rate is going to go down in 3 years. You are making a big bet, and I hope that you are right. But if you don’t. Be prepare for it.
Complexity of the 2-1 Buy Down Loan or just any loan in general
Loan is a complex animal. even for people who is in the real estate industry.
One of the way lender make money is that they are charging origination point. let say one point of a $100,000 loan is $1000, together with other fees in order to process your loan. They can also give back credit, if you select a higher rate, let say if you are going to take 8.5% rate, they will credit you back $2000. instead of charging you $1000. And you don’t even know for sure before you “lock it” which is somewhere half way when you get into the contract.
This is when thing get super confusing. and I haven’t add on the two one buy down yet! Lender can add credit, subtract the fee, add in miscelaious fee. Oh My!
The best advice I could give to any investor|home buyer is to work with a mortgage lender who value long term relationship and has your interest first, not their commission. They are hard to find but there are still lot of us out there with integrity. They can suggest thing like when is the best time to refinance for you, not for them.
You can just smell it when people just want their commission or dying for a quick transaction and move on to the next lead.
It does not hurt to talk to one or two or three lenders to compare their process, fee and their experience with solving difficult loan. Annyone can close a W2 loan, dual income with their eye closes. What about the person with multiple rentals in a complex legal structure that look super poor on paper for asset protection purpose?
I’m over simplifying this example for demonstration purpose but let see you are given with 3 option. No lender credit or fee to keep it really really simpple
A Buy down loan program for 5% interest on the 1st year, 6% on 2nd year, and 8% interest for year 3 and the rest of the life on the loan.
A Traditional 30 years fix rate loan for 7.5%
A 5 year ARM fix at 7%. Then float.
If you are planing to move or sell the house within 2 years, which option?
If you are planning to stay in your foreverhome..forever which option?
If you are planning to move or sell within 5 years, which option?
Run the numbers
Most typical buyer only care about the payment amount. This is where loan shark can take advantage of you buy asking “how much you can afford a month?” Then from that, they reverse engineer it into rate and amoritization schedule that might not be the best choice for the buyer
At the end of the way, what matter is the actual interest rate, is it fix or not, and how long is the loan. That’s all there is to it.
The 2-1 Loan Buy Down Program can be a game-changer for those looking to maximize their mortgage savings during the early years of homeownership or reduce their monthly mortgage payments. However, it is a double ledge sword that could make you over leverage on year 3 if you don’t have an exit plan.
you can hope the interest rate will go down in year 3. I hope so too, but hope is not a strategy.
If you’re interested in this program, consult with a reputable mortgage lender to discuss your options, assess your eligibility, and find the best mortgage solution for your unique needs. don’t run into a loan shark!
In conclusion, the 2-1 Loan Buy Down Program is for sophisticated buyer and investor that understand what they are getting into and have an exit strategy, or Plan B and Plan C for their investment.
First time home buyer should spend time to educate themselves more about the program and understand the financial impact when thing does not go as planned. Have a plan B.
Hope is not a plan B.