What is a Buydown, 3-2-1 Buydown, 2-1 buydown and 1-0 buydown?

A buydown can be very beneficial to somebody looking for a big loan but won’t have the money to make the monthly payments for a few years. It is fairly simple. Basically, it provides a way to lower the interest rate on your home loan temporarily. The way buydowns work is when somebody takes out a mortgage they can pay points to “buy down” the interest rate. One way to look at it is prepaying interest. Now, in order to buy down the interest, a lump sum is paid and set into an escrow account, which, in turn, is used to supplement the borrowers monthly payments. The seller of the house usually pays for this lump sum as a financial incentive for somebody to buy their property. Sometimes the lender will pay the lump sum; this is known as a “lender funded buydown.” The reason a lender would provide the lump sum is usually because they make the note rate on the buydown higher than the market rate. So, once all the buydown adjustments are over with the lender will be making more money off of a higher interest rate.

For Example: If the going interest rate is 7%, the lender might make the note rate at 8%. If you were to get a 3-2-1 buydown, the interest in the first year would be 5%, the second year it would be at 6%, the third year it would be 7%, then every year after that the interest rate would be 8%.

This is beneficial to both the lender and the borrower. The lender will get all his/her money and most likely more back from the higher interest rate. The borrower, on the other hand, is able to qualify for the loan because of the initial lower interest rate. As stated earlier, it can really help somebody out if they are expecting a higher salary in the next couple of years. That way they can qualify for the bigger loan now and be able to afford it when time requires it. Let’s take a look at the different types of temporary buydowns

• 3-2-1 Buydown – This buydown brings down the interest rate the most. Generally, you pay a total of 6 points to get a 3-2-1 buydown. For the first year the interest rate on your mortgage goes down 3% from the note rate. The second year it comes up to 2% below the note rate. Finally, the third year it comes to 1% below the note rate. After that the interest rate stays at the note rate for the remainder of the loan. A 3-2-1 buydown requires a larger lump sum than the other two to supplement your monthly payments over a longer period of time at a lower interest rate.
• 2-1 Buydown - This is similar to the 3-2-1 buydown except during the first year of the loan the interest rate goes down 2% from the note rate. It will then move to 1% below the note rate during the second year. From the third year on, the interest rate will equal note rate. This type of buydown will cost you 3 points. The lump sum required is not as great as for that of a 3-2-1 buydown but greater than that needed for a 1-0 buydown.
• 1-0 Buydown - This is the shortest Temporary Buydown and will bring your interest rate down 1% from the note rate for the first year. Every year afterwards will have an interest rate equal to the note rate. This buydown will cost you 1 point, and it will have the smallest lump sum in the escrow account.

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