What is the 2-1 buy down that lenders are talking about?

In the short period between early August and late October the average interest rate for a 30 year mortgage spiked from 5.50% to about 7.20%. As a result lenders shifted their marketing focus to something we haven’t seen in years while rates have been outrageously low – seller paid buy downs of interest rates to make monthly payment more affordable for potential buyers of their home.  In particular this time around they are promoting what is known as a 2-1 buy down.  If you have heard that term tossed around but are not familiar, here is a quick breakdown.

• In year 1 of your mortgage the interest rate is 2% less than what your rate would have been (for example if rates were 7.2%, you pay only 5.2% for your first year)
• In year 2 of your mortgage the interest rate is 1% less than what your rate would have been (so 6.2% in the scenario above)
• In year 3 and beyond it is the the full interest rate

Why are lenders advertising this?  Many think that rates will slip back down sometime in the next 2 years and those buyers will benefit from more manageable payments in the short term and hopefully have the ability to refinance into a lower fixed rate before they have to start making those full payments.

Why would a seller consider this, after all it would be costing them the thousands of dollars that the buyer will be saving?   The common thought is if market values of homes are dropping because of the higher interest rates resulting in higher monthly payments for buyers sellers might be willing fork over say +/-$10k at closing to fund this buy down if it helps them avoid having to reduce their price by say $25k or more.

Are we seeing this in action in our local market here in Central NJ?  I  have not seen it come into play on any transactions handled by our company yet. This is likely because the market in Middlesex and Monmouth County remains strong as a result of low inventory. As of this week all of Middlesex County  – a county with over 800,000 residents  – had only about 600 single family homes for sale (not counting  townhouses / condos).   There may be parts of the country where inventory levels have already expanded and the 2-1 buy down is more prevalent and practical. We will see what the future holds for our corner of the world.