What Is a Buydown?
A buydown is a mortgage financing strategy in which the buyer tries to get a reduced interest rate for at least the first few years, if not the full term of the loan.
During instance, a 2-1 buydown is a sort of mortgage buydown that allows homebuyers to save money on their interest rate for the first two years of the loan. A 3-2-1 arrangement can also be used for buydowns.
How does a Buydown work?
If you think of a buydown as a mortgage subsidy granted by the seller on behalf of the buyer, it’s easy to grasp. The seller usually provides cash to an escrow account that subsidizes the loan during the initial years, resulting in a cheaper monthly mortgage payment. This reduced down payment makes it easier for the homeowner to qualify for a mortgage. A buydown option may be offered by builders or sellers to assist enhance the likelihood of the property being sold by making it more affordable.
The mortgage-lending institution generally receives money from the builder or seller of the home, which lowers the buyer’s monthly interest rate and, as a result, monthly payment. The house seller, on the other hand, will almost always raise the purchase price of the home to cover the costs of the buydown arrangement.
Types of Buydowns
In a 3-2-1 buydown, the buyer makes reduced monthly payments for the first three years of the loan. The buyer’s interest rate would climb by 1% yearly for the first three years of the mortgage. Beginning in the fourth year of the mortgage loan, the full interest rate would apply.
The structure of a 2-1 buydown is similar to that of a 3-2-1 buydown, however the discount is only available for the first two years. So you’d get a 2% interest rate decrease for the first year of the mortgage, then a 1% rate reduction for the second year.
Benefits of a Buydown
- Savings with interest. Choosing a buydown might save you money on interest for the first two or three years of your mortgage (with a 2-1 buydown) or three years (with a 3-2-1 buydown).
- Reduced price. If a seller offers to pay a portion of the buydown price, the cost of the home could be reduced.
- Gradually increase your payments. If you’re just starting out in your job and expect your salary to improve, you might not have any trouble keeping up with your increasing mortgage payments over time.
Financial Consultant and Author