An interest rate buydown helps homebuyers temporarily reduce their monthly mortgage payments by lowering the loan’s interest rate for an initial period, generally one to three years. This is achieved by paying an upfront fee to the lender at closing, which funds the difference between the reduced payments and what the lender would normally receive at the higher rate.
How Does an Interest Rate Buydown Work?
When you agree to a buydown, the upfront money is placed into an escrow-like account. Each month, the lender uses those funds to subsidize your mortgage payment, effectively “buying down” the interest rate for the buydown period. After this period ends, your monthly payments adjust back to the original loan rate agreed upon in your mortgage contract.
Common Buydown Types: 2-1 and 3-2-1
The most prevalent structures include 2-1 and 3-2-1 buydowns, which gradually increase your interest rate each year until it reaches the permanent loan rate.
- 2-1 Buydown: Year 1 rate is 2% lower; Year 2 is 1% lower; Year 3 onward returns to the full rate.
- 3-2-1 Buydown: Year 1 rate is 3% lower; Year 2 is 2% lower; Year 3 is 1% lower; Year 4 returns to the full rate.
For example, with a $350,000 loan at a permanent 7% rate, a 2-1 buydown might reduce your initial payments by hundreds of dollars monthly, easing your financial transition.
| Year | Effective Rate | Approx. Monthly Principal & Interest | Monthly Savings |
|---|---|---|---|
| Year 1 | 5% | $1,879 | $449 |
| Year 2 | 6% | $2,098 | $230 |
| Year 3-30 | 7% | $2,328 | $0 |
(Note: Does not include taxes and insurance.)
Who Typically Pays for the Buydown?
Buydowns can be funded by:
- Sellers: To attract buyers in slow markets by making monthly payments more affordable.
- Builders: To market new construction homes by offsetting higher interest rates.
- Buyers: Sometimes buyers pay to buy down their rate if they anticipate higher future income or want lower initial payments.
Buydown vs. Paying Points
Unlike a permanent rate reduction obtained by paying discount points (which lowers the mortgage rate for the life of the loan), a temporary buydown only reduces the rate for a limited time. Lenders still qualify buyers based on the full note rate, which is important to understand when assessing affordability.
Advantages and Considerations
Pros:
- Reduces initial payments, helping with cash flow.
- Eases the financial transition into homeownership.
- Often paid by sellers or builders, costing the buyer little or nothing upfront.
Cons:
- Payments increase after the buydown period, sometimes substantially.
- Qualification is based on the full interest rate, so a buydown doesn’t lower qualifying income requirements.
- If sellers pay for the buydown, it may be reflected in the home’s sale price.
Additional FAQs
What if I refinance or sell during the buydown period? Remaining funds in the buydown account typically apply toward the loan principal, benefiting you by reducing the remaining balance.
How much does a buydown cost? The cost equals the total interest savings during the reduced-rate period. For example, a 2-1 buydown’s two-year savings translate to the upfront fee the lender requires.
Are buydowns available for all loans? Buydowns are common with Conventional, FHA, and VA loans but depend on the lender’s offerings.
For more details, see the Consumer Financial Protection Bureau’s guide on buydowns and Investopedia’s explanation.
