3-2-1 Buydown Mortgage

A 3-2-1 buydown mortgage is a type of loan that starts out with a low interest rate and rises over the next several years until it reaches its permanent rate.

Here is how 3-2-1 buydown mortgages work and how to decide if one is right for you.

How 3-2-1 Buydown Mortgages Work

A buydown is a mortgage-financing technique that allows a homebuyer to obtain a lower interest rate for at least the first few years of the loan, or possibly its entire life, in return for an extra up-front payment. It is similar to the practice of buying discount points on a mortgage in return for a lower interest rate.

Either the homebuyer/borrower or the home seller may cover the costs of the buydown.

In general, 3-2-1 buydown loans are available only for primary and secondary homes, not for investment properties. The 3-2-1 buydown is also not available as part of an adjustable-rate mortgage (ARM) with an initial period of fewer than five years.

In a 3-2-1 buydown mortgage, the loan’s interest rate is lowered by 3% in the first year, 2% in the second year, and 1% in the third year. The permanent interest rate then kicks in for the remaining term of the loan. In a 2-1 buydown, by contrast, the rate is lowered by 2% during the first year, 1% in the second year, and then goes to the permanent rate after the buydown period ends.

Pros and Cons of a 3-2-1 Buydown Mortgage

A 3-2-1 buydown mortgage can be an attractive option for homebuyers who have some extra cash available at the outset of the loan, as well as for home sellers who need to offer an incentive to facilitate the sale of their homes.

It also can be advantageous for borrowers who expect to have a higher income in future years. Over the first three years of lower monthly payments, the borrower can also set aside cash for other expenses, such as home repairs or remodeling.

When the loan finally resets to its permanent interest rate, borrowers have the certainty of knowing what their payments will be for years to come, which can be useful for budgeting. A fixed-rate 3-2-1 buydown mortgage is less risky than the above-mentioned ARM or a variable-rate mortgage, where rising interest rates could mean higher monthly payments in the future.

A potential downside of a 3-2-1 buydown mortgage is that it may lull the borrower into buying a more expensive home than they will be able to afford once their loan reaches its full interest rate. Borrowers who assume that their income will rise in line with future payments could find themselves in too deep if their income fails to keep pace.

Examples of Subsidized 3-2-1 Buydown Mortgages

In many situations, the up-front costs of a 3-2-1 buydown will be covered by someone other than the homebuyer. For example, a seller might be willing to pay for one to seal the deal. In other cases, a company moving an employee to a new city might cover the buydown cost to ease the expense of relocation. More commonly, real estate developers will offer buydowns as incentives to potential buyers of newly built homes.

Is a 3-2-1 Buydown Mortgage Right for Me?

If you will need to pay for the buydown on your own, then the key question to ask yourself is whether paying the cash up front is worth the several years of lower payments that you’ll receive in return. You might, for example, have other uses for that money, such as investing it or using it to pay off other debts with higher interest rates, like credit cards or car loans. If you have the cash to spare and don’t need it for anything else, then a 3-2-1 buydown mortgage could make sense.

As mentioned earlier, however, it can be risky to go with a 3-2-1 buydown mortgage on the assumption that your income will rise sufficiently over the next three years so that you’ll be able to afford the mortgage payments when they reach their maximum. For that reason, you’ll also want to consider how secure your job is and whether unforeseen circumstances could come along that would make those payments unmanageable.

The question is easier to answer when someone else is footing the bill for the buydown. In that case, you’ll still want to ask yourself whether those maximum monthly payments will be affordable when the time comes—or whether the enticingly low initial rates could be leading you to buy a more expensive home and take on a bigger mortgage than makes sense financially. You’ll also want to make sure that the home is fairly priced in the first place and that the seller isn’t padding the price to cover its buydown costs.

These are questions that only you can answer, but you may find this Investopedia article on How Much Mortgage Can You Afford? helpful.

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