A temporary interest rate buydown on your mortgage is a temporary reduction in your rate and payment. It could make homebuying more affordable.
Mortgage rates got you down? There is a loan option available to many buyers to combat high rates, and it’s gaining in popularity. It’s called a temporary interest rate buydown, and it gives potential homebuyers more flexibility in times when rates are higher than many homeowners are comfortable paying.
An interest rate buydown decreases the buyer’s monthly mortgage payment for a set number of years, usually the first two years of homeownership, but a buydown can also come in the three-year variety or the one-year variety, depending on the situation. Whatever form your interest rate buydown takes, it frees up funds and makes buying a home more affordable.
Here's how to buy a home using a 2-1 buydown.
A 2-1 buydown is a program in which a home buyer, seller and/or builder pays to reduce the buyer's mortgage rate temporarily, making the first two years of homeownership more affordable.
The party funding the buydown, whether it is the seller, builder or buyer, kicks in enough money to reduce the buyer's mortgage rate by 2% the first year and 1% the second year as part of that party’s closing costs. The mortgage carries the standard rate and payment in years 3-30.
Here's how a temporary buydown might play out using hypothetical interest rates. For the purposes of this hypothetical example, consider a $300,000 home purchase with a mortgage interest rate of 6%.*
*Principal and interest only. Taxes, insurance or HOA not included. Rates and payments are for example purposes only and may not reflect currently available rates. Not an offer to lend.
This structure saves the buyer $367 per month the first year and $189 per month the second year on a $300,000 mortgage. These extra funds can go a long way toward making a home more affordable, just when a new homebuyer needs it most.
Another structure the interest rate buydown sometimes takes is the 1-0 buydown. This is when the seller, builder or buyer buys down the interest rate for the first year only. Fairway currently has options for 2-1 rate buydowns, 1-0 rate buydowns and 3-2-1 rate buydowns, which allow for even greater savings across the first three years of the loan term instead of one or two.
In higher rate atmospheres, adjustable-rate mortgages become more popular. They give the homebuyer the flexibility of knowing that after their introductory rate period, their rate may go down as market rates decrease. But they come with risks, too. Typically, after the introductory rate period, their interest can increase up to 1% per year for five years, which can leave you with a higher rate than expected if rates continue to climb.
An interest rate buydown, however, is more predictable. It's a fixed-rate loan. You know exactly what your payment will be in year one, year two, and years 3-30. However, it still gives you a low introductory payment when you need it most: at the beginning of your loan.
If you like the idea of more affordable mortgage payments during the first one, two or three years of your loan term, but don't like the idea of an adjustable-rate mortgage, a 2-1 buydown might be the right plan for you.
The seller prepays a portion of each month's payment for the first two years as part of their closing costs, effectively bringing down the payment as if the rate was reduced. The mortgage rate the buyer qualifies for on the mortgage does not actually change. Here's how that works.
The lender adds up the entire subsidy required to reduce the payment over two years. Then the party funding the buydown, whether it is the seller, builder or buyer, contributes that much into an escrow account to be drawn on each of the first 24 months of the loan.
Here's an example of seller-paid incentives that reduce the payment on the same hypothetical* $300,000 home we discussed earlier.
*Principal and interest only. Taxes, insurance or HOA not included. Rates and payments are for example purposes only and may not reflect currently available rates. Not an offer to lend.
In this scenario, the party funding the buydown pays $6,672 reduction into escrow, so that the buyer’s monthly payments are lowered that exact amount over the first two years of the mortgage.
The seller or builder might offer a temporary buydown to attract more buyers to the property. Another option is that the buyer could request this incentive in negotiations through their Fairway mortgage advisor and their real estate agent if they are considering a home that has no other offers or is priced higher than the potential buyer’s liking.
A 2-1 or 1-0 buydown could attract a buyer and encourage an offer on one home over others. It could be a win-win for buyer and seller.
Typically, buydowns work best when the seller or builder is paying for most of the temporary buydown. However, you're allowed to contribute to your own buydown as well, with limits.
Buydowns are typically only allowed for the purchase of a 1-2 unit home that you plan to live in. Triplexes, fourplexes, or investment properties are usually not eligible for interest rate buydown programs.
Additionally, you can only combine a 2-1 buydown with certain loan types. Check with your lender if you are using an FHA loan, VA loan, USDA loan, HomeReady, or other programs. Sometimes there is a buydown program compatible with these loan types, but sometimes there are not. Keep in mind that there are limits to how much the seller can contribute toward the purchase. A buydown is considered an interested party contribution, or IPC, and there is a maximum cap for IPCs with nearly every type of home loan.
For instance, if you're putting less than 10% down on a Conventional loan, the seller contribution maximum is 3% of the home's price. On a $300,000 home, that's $9,000, so that will be the maximum amount the seller can contribute to any buydown. In fact, combined contributions from the seller, agent, lender or any other party in the transaction must not exceed that amount. The contribution limits rise as your down payment increases, though.
As the buyer, you're also limited to paying 3% toward your own rate reduction due to lending rules in the above scenario. Check with your lender for your loan type and down payment amount and make sure whether your buydown total falls within the guidelines.
No. You have to qualify for the mortgage assuming the full payment. An interest rate buydown doesn't help you qualify for the loan itself if your debt-to-income ratio (DTI) is too high. A borrower's DTI is his or her monthly debt/expenses divided by his or her gross monthly income.
An interest rate buydown works well in many situations:
What is a 2-1 buydown? A 2-1 buydown is when a home seller effectively buys down a homebuyer's mortgage rate by 2% the first year and 1% the second year. In years 3-30, the mortgage rate returns to its standard level.
How much does a 2-1 buydown cost? A 2-1 buydown costs the difference between the standard mortgage payment and the reduction in payments for two years. The rate is reduced by 2% the first year and 1% the second year. The cost depends on the base interest rate and loan amount. For example, if the payment is reduced by $200 the first year and $100 the second year, the total cost of the buydown would be ($200 X 12) + ($100 X 12) = $3,600.
What is a 3-2-1 buydown? A 3-2-1 buydown is when the seller or another party in the transaction pays to reduce the rate by 3% the first year, 2% the second year, and 1% the third year. In years 4-30, the standard rate and payment apply.
What is a 1-0 buydown? This is similar to a 2-1 buydown, but the rate is reduced by 1% the first year and returns to the base rate and payment in years 2-30.
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*The borrower is required to qualify at the full note rate. Not all temporary buydown options are available for every product or scenario. Talk to your Fairway Loan Officer for more details. A 3 year (3/2/1) temporary rate buydown will reduce the note rate by 3% for the first year of the term, followed by a 2% reduction of the note rate for the second year of the term, followed by a 1% reduction of the note rate for the third year of the term, after which the rate will then revert back to the original note rate for the remainder of the term. A 2/1 temporary rate buydown will reduce the note rate by 2% for the first year of the term, followed by a 1% reduction of the note rate for the second year of the term, after which the rate will then revert back to the original note rate for the remainder of the term. A 1/0 temporary rate buydown will reduce the note rate by 1% for the first year of the term, after which the rate will revert back to the original note rate for the remainder of the term. Copyright©2023 Fairway Independent Mortgage Corporation. NMLS#2289. 4750 S. Biltmore Lane, Madison, WI 53718, 1-866-912-4800. All rights reserved. This is not an offer to enter into an agreement. Not all customers will qualify. Information, rates, and programs are subject to change without prior notice. All products are subject to credit and property approval. Not all products are available in all states or for all dollar amounts. Other restrictions and limitations may apply. Fairway is not affiliated with any government agencies. Fairway is required to disclose the following license information. AZ License #BK-0904162; Licensed by the Department of Financial Protection and Innovation under the California Residential Mortgage Lending Act, License No 41DBO-78367. Licensed by the Department of Financial Protection and Innovation under the California Financing Law, NMLS #2289. Loans made or arranged pursuant to a California Residential Mortgage Lending Act License; Georgia Residential Mortgage Licensee #21158; For licensing information, go to www.nmlsconsumeraccess.org; MA Mortgage Broker and Lender License #MC2289; Licensed Nevada Mortgage Lender; Licensed by the NJ Department of Banking and Insurance; Licensed Mortgage Banker-NYS Department of Financial Services; Rhode Island Licensed Broker & Lender; Fairway Independent Mortgage Corporation NMLS ID #2289 (www.nmlsconsumeraccess.org). Equal Housing Opportunity.
