A 3-1 buydown is a mortgage agreement that provides for a low interest rate for the first year of the loan, a somewhat higher rate for the second year, and then the full rate for the third and later years.

KEY TAKEAWAYS

• A 3-1 buydown is a type of financing that lowers the interest rate on a mortgage for the three years before it rises to the regular, permanent rate.
• The rate is typically two percentage points lower during the first year and one percentage point lower in the second year.
• Sellers, including home builders, may offer a 3-1 buydown to make a property more attractive to buyers.
• 3-1 buydowns can be a good deal for homebuyers, provided that they will be able to afford the higher monthly payments once those begin.

How 3-1 Buydowns Work

A buydown is a real estate financing technique that makes it easier for a borrower to qualify for a mortgage with a lower interest rate. That lower rate can last for the duration of the mortgage (as is often the case when borrowers pay extra points up front to the lender) or for a particular period of time. A 3-1 buydown is one kind of temporary buydown, in this case lasting for two years.

In a 3-1 buydown, the interest rate will increase from one year to the next until it settles into its permanent rate in year three. To make up for the interest that they won’t be receiving in those early years, lenders will charge an additional fee.

Either a homebuyer or a home seller can pay for a buydown. That payment may be in the form of mortgage points or a lump sum deposited in an escrow account with the lender and used to subsidize the borrower’s reduced monthly payments.

Sellers, including home builders, often use 3-1 buydowns as an incentive for potential purchasers.

Example of a 3-1 Buydown Mortgage

Suppose a real estate developer is offering a 3-1 buydown on its new homes. If the prevailing interest rate on 30-year mortgages is 6.5%, a homebuyer could get a mortgage that charged just 3.5%in the first year, then 4.5% in the second year, and 5.5% after that back to 6.5 

When to Use a 3-1 Buydown

Home sellers may want to consider offering (and paying for) a 3-1 buydown if they’re having difficulty selling and need to provide an incentive to find a buyer.

Borrowers may benefit from a buydown if it allows them to buy the home they want at a price they can afford. However, they will also want to consider what would happen if their income doesn’t rise fast enough to keep up with their future monthly payments.

Buyers should also make sure that they are getting a fair deal on the home in the first place. That’s because some sellers might increase the home’s price to make up for the cost of the 3-1 buydown.

Note that buydowns may not be available under some state and federal mortgage programs or from all lenders. A 3-1 buydown is available on fixed-rate Federal Housing Administration (FHA) loans, but only for new mortgages and not for refinancing. Terms can also vary from lender to lender.

Buydowns can be 3-1 2-1 or 1-1 

Who Can Buy Down A Mortgage?

Although it’s the buyer (or borrower) who benefits from a buydown, the buyer isn’t always the one who buys down a mortgage. Sellers and builders can also be responsible for purchasing points to lower the buyer’s interest rate.

Buyers

The majority of buydowns are negotiated between buyers and lenders. Home buyers offer to pay a specific number of points upfront, and in return, they receive a lower interest rate, making their mortgage more affordable for a certain number of years or over the loan term, depending on the buydown structure.

Sellers

Sellers may also offer to buy down a buyer’s mortgage to incentivize the buyer to purchase their home. In these circumstances, the seller will make the one-time payment and deposit it into an escrow account or pay for points over the entire loan term as part of seller concessions.

This payment, or subsidy, provides the lender with the funds necessary to lower the buyer’s interest rate so that the buyer can more easily afford their home loan. However, to make up for this expense, especially in a seller’s market, the seller often will add the cost of the subsidy to the purchase price of their home.

Builders

Like sellers, builders may also offer to pay points to buy down buyers’ mortgages. Typically, a builder will make these upfront payments to entice early buyers to purchase properties in their newly built communities. Once their communities are established, builders are usually less inclined to offer this kind of incentive.

How Buydowns Are Structured

Since buydowns are negotiated, they can be arranged in a variety of ways. In addition to buydowns over the life of the loan, common structures that lenders use are the 1-0 buydown and the 2-1 buydown. A 3-2-1 buydown is less common. However, regardless of the structure, the principles are the same.

The buyer, seller or builder will pay the lender the difference between the standard interest rate and the lowered rate through points at closing. The buyer will benefit from the reduced interest rate until the buydown expires, usually after a few years. Not all buydowns expire. If one does, the buyer will have to pay the standard interest rate for the remainder of the term, which will cause their monthly mortgage payments to increase.

1-0 Buydown

With a temporary 1-0 buydown, your interest rate is 1% lower than what your contract rate would be for the rest of the loan for the first year.

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