Many new products and programs have come down into our product offerings at All Western Mortgage. With some of the new products we now offer, we can approach our clients with better solutions for their home mortgage when they are buying a home. In this blog, I go over a unique product called a 2-1 Buy Down.
2-1 Buy Down for FHA and Conventional Purchase Loans
The name of this product sounds like one of those loans from pre-2008 but is far from that family of products. A 2-1 Buy Down allows a borrower to lock an interest rate 2% below the Note rate for the first year, then the rate increases by 1% the second year. Once years one and two are complete, the interest rate becomes the true Note rate that was locked. This is a 30 year “fixed” rate loan. See below for a quick example:
Initial Note rate locked 5.875%
1st year interest rate 3.875%
2nd year interest rate 4.875%
Sample Scenario Conventional Loan scenario
Purchase Price: $350,000
Loan Amount: $332,500 (5% down payment)
Principle & Interest Payments:
$1,563.54 @ 3.875%
$1,759.62 @ 4.875%
$1,966.86 @ 5.878%
Summary: What You can do
The savings on the payment between year one and year three is nearly $400 a month. Then it comes down to $200 a month. A borrower must qualify on the actual Note rate, which in this example is 5.875%. But getting away with a lower monthly payment is not why someone will use this product. In fact, if this is your motive, I would not recommend this. The advantage of this product allows a borrower to pay that “savings” toward reducing the principle of the loan or money borrowed. Come year three, the borrower will want to refinance into a new mortgage to eliminate the mortgage insurance. Between the equity appreciation and reduced principle on the loan, they will eliminate mortgage insurance on the new appraised value.
See the example of the equity gained and built:
$400-savings year one x 12 months = $4,800 additional principle reduction year one
$200-savings year two x 12 months = $2,400 additional principle reduction year two
Total additional Principle Reduction first 2 years: $7,200
Estimated Equity Appreciation by year three at 3% – 4% appreciation: $30k – $40k
Total principle reduction from P&I payments first 2 years: $11,200
Down Payment when purchased $17,500
Grand total: $65k – 75k Equity built, earned, & paid
Why this is helpful
Remember you must have 20% equity to refinance without paying any kind of mortgage insurance on a conventional loan. With the original purchase price at $350,000, a 20% down payment would mean $70,000. In 2 years, using a 2-1 Buy Down, you can leverage the lower initial rate to make your regular mortgage payment, applying funds to reduce the principle owned, and refinance into a lower payment by eliminating the mortgage insurance on the loan. If this were FHA, the same idea applies. The Note rate may be higher than today’s rates but remember we cannot predict the future and it’s possible the note rate is the same, lower, or higher than the market down the road.
With interest rates on the rise, I believe consumers should look at products that give them better overall value. You can plan your financial future a little easier with something like this and prepare your mortgage payment with more clarity with a product like the 2-1 Buy Down. Request a customized review for your purchase plans before committing to this program.