A 3-2-1 buydown mortgage is a type of home loan designed to make homeownership more affordable when high mortgage rates might otherwise price potential buyers out of the market. This loan reduces the interest rate for the first three years. From the fourth year onwards, the original rate is applied for the remainder of the mortgage term.
Read on to learn how a 3-2-1 buydown mortgage works and whether it might be the right fit for your financial needs.
Key Takeaways
- Lower Initial Rates: With a 3-2-1 buydown mortgage, the borrower enjoys reduced interest rates over the first three years.
- Yearly Rate Reduction: The rate is reduced by 3% in the first year, 2% in the second year, and 1% in the third year; for example, a 5% mortgage would be just 2% in year one.
- Original Rate Resumes: After the initial period, the full interest rate is charged for the rest of the mortgage term.
- Helpful for Sellers: Sellers, including home builders, often use buydowns to assist buyers in affording their property.
How a 3-2-1 Buydown Mortgage Works
A buydown is a mortgage-financing technique that allows homebuyers to secure a lower interest rate for the initial years of the loan. This is similar to buying discount points on a mortgage in exchange for a lower rate, though a buydown’s effect is temporary.
Typical Payment Covers: In many cases, the seller or homebuilder covers the cost of the 3-2-1 buydown. The cost equates to the buyer’s savings over the first three years.
Eligibility Restrictions: Generally, 3-2-1 buydown loans are available only for primary and secondary homes, not for investment properties. They are also not available as part of an adjustable-rate mortgage (ARM) with an initial period shorter than five years.
Rate Reduction: The interest rate for a 3-2-1 buydown mortgage is reduced by 3% for the first year, 2% for the second year, and 1% for the third year. The original interest rate is then applied for the remaining term.
Pros and Cons of a 3-2-1 Buydown Mortgage
Pros
- Affordability: Makes buying a home more attractive in high-interest rate environments.
- Seller Assistance: Allows home sellers to entice buyers in challenging housing markets.
- Future Income: Beneficial for buyers expecting higher future incomes.
- Budgeting Ease: The lower initial payments allow for better financial planning and emergency fund saving.
- Certainty: Offers fixed-rate stability once the permanent interest rate kicks in.
Cons
- Overspending Risk: Could encourage buyers to purchase more expensive homes than they can truly afford.
- Temporary Relief: Requires preparedness for higher payments when the initial lowering period ends.
- Income Risks: Relies on the assumption of rising future income, which can be unpredictable.
Who Subsidizes 3-2-1 Buydown Mortgages?
Typically, the seller, homebuilder, or lender covers the 3-2-1 buydown mortgage cost. For example, sellers may do this to attract buyers, or a company may pay to ease an employee’s relocation burden. It’s also common for real estate developers to offer buydowns as incentives for new homes.
Is a 3-2-1 Buydown Mortgage Right for You?
It’s crucial to assess the risk involved in assuming your income will rise enough to cover future higher payments. Consider the security of your job and any unforeseen circumstances that might make payments unmanageable.
If required to pay for the buydown from your pocket, weigh whether the up-front cost is worthwhile compared to other potential financial allocations, like investing or paying off high-interest debts. When covered by another party, confirm that the maximum future payments are manageable within your budget. Ensure the home is fairly priced without added buydown costs.
What Does a 3-2-1 Buydown Mortgage Cost?
The cost is the total savings enjoyed by the buyer over the three years of initially reduced rates.
Who Pays for a 3-2-1 Buydown Mortgage?
Usually, someone other than the buyer covers the buydown mortgage cost, such as the seller, homebuilder, or lender. Occasionally, an employer will cover the cost for relocating employees.
Is a 3-2-1 Buydown Mortgage a Good Deal?
A 3-2-1 buydown mortgage can offer significant benefits if someone else covers its cost. Buyers, however, need to be certain they’ll manage the full mortgage payments from the fourth year onward to avoid financial strain or potential home loss.
The Bottom Line
A 3-2-1 buydown mortgage offers a valuable tactic for homebuyers to surmount high-interest-rate obstacles and make initial homeownership manageable. However, careful planning is essential, understanding that from the fourth year, payments will be at the original interest rate for the mortgage’s life.
Related Terms: fixed-rate mortgage, adjustable-rate mortgage, discount points, investment properties.
References
- American Pacific Mortgage. “Understanding a 3-2-1 Interest Rate Buydown”.
