If you want to buy a home while keeping mortgage rates low, consider a buydown mortgage. Especially with current high interest rates, a 3-2-1 buydown mortgage means that you'll get reduced interest rates for the first three years of the loan. You'll need to pay the original interest rate from the fourth year. While this mortgage can make sense for many families, read on to understand how a 3-2-1 buydown works and whether it will fit your needs.
Understanding 3-2-1 Buydown Mortgages
A 3-2-1 buydown mortgage is a type of mortgage buydown that allows borrowers to pay less for set terms. A buydown means that the borrower has paid an upfront fee or lump sum in exchange for lower interest rates for a set period of time. This results in lower interest rates for a set period, usually one to three years.
A buydown may allow a borrower to take advantage of lower mortgage payments for that time. A mortgage buydown can make sense if you plan to see a significant salary increase or other change in your financial situation. Home builders and developers often offer buydown mortgages to help buyers afford a property.
In the case of a 3-2-1 buydown mortgage, you'll pay a lower interest rate for the first three years of the loan. Usually, you'll get the normal interest rate reduced by 3% for the first year, 2% for the second year and 1% in the third year. If your interest rate is 6%, you'd pay just 3% interest the first year, 4% the second year and 5% the third year. After the buyout period, you'll continue paying the full 6% interest rate for the loan duration.
How Does a 3-2-1 Buydown Loan Work?
A buydown is a type of mortgage financing that can help you get a lower interest rate. Unlike purchasing discount points for a lower interest rate, a buydown only grants you a lower interest rate for a limited time, usually a few years. However, for many homebuyers, that's enough to secure home ownership. Interest rates for a 3-2-1 buydown mortgage are reduced by:
- 3% for the first year
- 2% for the second year
- 1% for the third year
From the fourth year, you'll pay the full agreed-upon mortgage rate. The buydown cost is equal or nearly equal to the savings in interest on the mortgage for the three years. Sellers, often home builders or developers, will cover the cost of the 3-2-1 buydown as a financial incentive to close the sale.
For example, if you plan to buy a home for $300,000 with a 7% interest rate and the seller offers a 3-2-1 buydown mortgage, you'll pay 4% interest the first year, 5% the second year, and 6% the third year before the full interest rate takes effect for the duration of the loan.
An alternative to a 3-2-1 buydown is a 2-1 buydown, in which the interest rate is only reduced for two years. The rate is reduced by 2% in the first year and 1% in the second year before returning to the agreed-upon interest rate in the third year.
A 3-2-1 buydown loan is available for a primary or secondary home but not for investment properties. A 3-2-1 buydown is usually only available for fixed-rate mortgages. If you're interested in an adjustable-rate mortgage (ARM) with an initial period of less than five years, a buydown won't work.
3-2-1 Buydown and Buying Discount Points: What’s the Difference?
A 3-2-1 buydown is similar to buying discount points, except that it's a temporary rate reduction.
Discount points are a one-time fee paid directly to the lender that will then reduce mortgage interest rates for the duration of the loan. In contrast, the interest rate reduction from a 3-2-1 buydown is three years.
Who Should Consider a 3-2-1 Buydown?
Buyers who need a lower monthly payment for the first few years of homeownership could consider a 3-2-1 buydown. It could help secure a loan if you're working in a career with a lower income but expect a significant salary increase. For example, new medical doctors in their residency could get a 3-2-1 buydown while preparing for a full-time career. Likewise, professionals in careers with significant growth potential and a stable position could consider a 3-2-1 buydown.
On the other hand, if you're buying a home that needs significant renovations or repairs, the three-year reprieve on interest rates could give you the extra cash needed for repairs. A buydown mortgage can also make sense for anyone with a stable income who expects additional expenses in the next one to three years.
How Much Does a 3-2-1 Buydown Cost?
The cost of a 3-2-1 buydown mortgage is the total amount you'll save over the three years of lower rates. For example, if the loan is for $100,000, with a 7% interest rate, in the first year, you'll save 3% or $3,000 in interest. You'll save $4,585 on interest, which you or the seller will pay for the buydown.
In this case, the monthly mortgage payments in the first year of the loan will be $477.42. In the second and third years, it will be $536.82 and $599.55, respectively. By the fourth year, the payments will increase to the full 7% interest rate of $665.30.
Sometimes, the seller or third party may offer a partial buydown payment. This can be expressed as a percentage of the total loan or a flat rate. In the example above, the seller may offer to pay 2% of the loan amount or a flat $2,000.
Who Pays for a 3-2-1 Buydown?
Who pays for a 3-2-1 buydown depends on the individual situation. Most commonly, the seller or developer will pay the buydown or at least a portion. However, in some cases, individual borrowers opt for a buydown themselves to pay less on monthly mortgage payments for a period of time.
Pros of 3-2-1 Buydown Mortgages
Should you use a buydown mortgage? Here are the advantages for you to consider.
- Lower monthly payments: This can make it easier for families just starting out or setting up a first home to have extra cash for other expenses, repairs or remodeling.
- Incentives for buyers: If the seller pays for the buydown, the additional savings can be a key incentive for buyers in slow housing markets.
- Secure home ownership: Buydown loans can help borrowers who expect to have higher incomes in future years to get into a favorable housing market.
- Set payments: Buydown mortgages are fixed-rate mortgages so you can plan your budget and other expenses.
Cons of 3-2-1 Buydown Mortgages
While 3-2-1 buydown loans can make sense for many people, they are not without a few significant disadvantages. Here's an overview to keep in mind:
- Increasing prices: As your mortgage payments increase each year for four years, some borrowers may realize they cannot comfortably afford the full mortgage payment.
- Risk of financial changes: If you are counting on a raise or reduction of other expenses, there's always a risk your financial situation could change. In that case, affording the higher mortgage payment can make it difficult to prepare for the increased payments.
Get the Best 3-2-1 Buydown Mortgages From Benzinga’s Top Home Loan Lenders
You can find buydown mortgages from some of Benzinga's top mortgage lenders. They could help you save more this year.
Should You Get a 3-2-1 Buydown Mortgage?
Whether a 3-2-1 buydown mortgage is right for you depends on your financial situation and goals. It can be a way to save more when buying a home, especially if the seller is paying the buydown costs. However, you should still compare mortgage lenders and the total interest and fees costs to ensure you secure the most favorable terms. Learn more about how mortgage interest rates work then find the best mortgage lenders here.
Frequently Asked Questions
How long does the reduced interest rate last in a 3-2-1 buydown mortgage?
The reduced interest rates on a 3-2-1 buydown mortgage lasts three years.
Can the interest rate ever go below the reduced rate in a 3-2-1 buydown mortgage?
No, interest rates won’t go below the reduced rate on a 3-2-1 buydown. If you want an interest rate that might reduce in the future, consider an adjustable-rate mortgage or refinancing a buydown mortgage when interest rates are lower.
Can the borrower refinance a 3-2-1 buydown mortgage?
Yes, a borrower can choose to refinance a buydown mortgage.
About Alison Plaut
Alison Kimberly is a freelance content writer with a Sustainable MBA, uniquely qualified to help individuals and businesses achieve the triple bottom line of environmental, social, and financial profitability. She has been writing for various non-profit organizations for 15+ years. When not writing, you will find her promoting education and meditation in the developing world, or hiking and enjoying nature.