An interest rate buydown temporary reduces a monthly mortgage payment for designed time period. Please visit the 2-1 buydown page for the mechanics and nuances of how buydowns work.
All interest rate buydowns fundamentally work the same; it’s the duration and start rates that are different. This article will cover those differences.
Interest Rate Buydown
This article will cover different types of buydown options. The aforementioned 2-1 buydown article outlines the details of how these work.
Please read the 2-1 buydown article to learn the mechanics of how buydowns work.
The amount of digits in the buydown name determines the number of years for the temporary reduction in payment. For example, a 1-1-1 buydown will reduce the monthly mortgage payment for three years.
There are five types of buydowns that will be covered in this article.
- 3-2-1 Buydown
- 1-1-1 Buydown
- 2-1 Buydown
- 1-1 Buydown
- 1-0 Buydown
The most commonly advertised buydown is the 2-1 buydown. Reason being, this is because it provides the biggest “wow” factor at a reasonable price.
Another key point, a home buyer must qualifying for the loan using the full payment based on the actual interest rate. In other words, the buydown does not make qualifying for home loan easier.
While buydowns are most often used when purchasing new construction homes, a seller can offer concessions for buydowns.
Rate Buydown Costs
Each interest rate buydown structure has different costs. These cost can only be paid by the seller. In other words, neither the lender nor the buyer may pay for the buydown.
The cost for the buydown increase the longer the buydown lasts and the greater the discounted rate. The 3-2-1 is the most expensive and the 1-0 is the least expensive buydown.
This interest buydown calculator estimates the sample cost of a buydown. Please note that this worksheet is for sample purposes only and is not a commitment to lend.
The following screenshots are from the buydown calculator are for a 3-2-1 buydown. This example shows a $400,000 purchase price with a 20% down payment.
As shown above, the total buydown cost for the seller is $14,761. That equates to 4.625% of the sales price.
Reasons to do a Buydown
Interest rate buydowns are always popular. Buydowns are predominately used when mortgage interest rates spike and are expected to moderate in the near future.
There are two main benefits to a buydown:
- temporary reduction in payment, and
- unused funds are credit to the homeowner.
Basically, the temporary reduction in the monthly payment reduces the payment shock of higher interest rates.
Rate Buydown Types
Below are the five most common buydown structures.
This buydown feature is the most aggressive in terms of lowering the monthly payment. Moreover, it’s also the most costly for the seller.
The 3-2-1 buydown reduces the payment for three years.
While in year 1, the monthly mortgage payments will be based on an interest rate that is 3% lower than the actual rate. The second year the mortgage payments will be based on a 2% lower rate than the actual interest rate. After that, the third year’s payment will based off a rate that is 1% lower than the actual rate. Finally, the full and actual payment will begin in year 4.
For example: Joe Buyer gets a 30 year fixed rate mortgage at 7% and uses a 3-2-1 buydown.
The payments for months 1 through 12 will be based off a 4% interest rate (7% minus 3%). Then year 2’s payments will be based off a 5% rate (7% minus 2%). Thirdly, the payment rate will be 6% (7% minus 1%) for year 3. Lastly, for years 4 through 30, the payment will be based of the actual rate of 7%.
The 1-1-1 buydown reduces the determining interest rate by 1% for all three years.
For example: Joe Buyer has a 30 year fixed rate mortgage with a rate of 7%. During the first 36 months, the 1-1-1 buydown payments will be based on a 6% interest rate (7% minus 1%). Afterwards, the payment will be based on the actual rate of 7% for year 4 and beyond.
As previously stated, please visit the 2-1 Buydown article for more details. That article will provide the details relating to all buydowns.
A 1-1 buydown will reduce the payment for two years. The temporarily reduced monthly payment will be the same for both years before increasing to the permanent payment in year 3.
Example: Joe Buyer’s permanent rate is 7%. With a 1-1 buydown the payment in both year 1 and in year 2 will be based off a 6% rate (7% minus 1%).
This 1-0 buydown gets advertised as the “inflation buster” program. Most lenders have access to this program; however, some lenders have bigger advertisement dollars and superior marketing teams.
This buydown reduces the payment for only one year. For example, a monthly payment will be based off a 6% interest rate for the first 12 months if the actual rate is 7%.