A 2-1 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.

How 2-1 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 2-1 buydown is one kind of temporary buydown, in this case lasting for two years.

In a 2-1 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 2-1 buydowns as an incentive for potential purchasers.

Example of a 2-1 Buydown Mortgage

Suppose a real estate developer is offering a 2-1 buydown on its new homes. If the prevailing interest rate on 30-year mortgages is 5%, a homebuyer could get a mortgage that charged just 3% in the first year, then 4% in the second year, and 5% after that.

If the homebuyer took out a $200,000, 30-year mortgage, for example, then their monthly payments during the first year would be $843. In the second year, they would pay $995. After the end of the second year, their monthly payment would rise to $1,074, where it would stay for the remainder of the mortgage.

2-1 Buydown Pros and Cons

For home sellers, a 2-1 buydown can help them by making it easier and sometimes faster for them to sell their homes for a good price. The downside, of course, is that it comes at a cost, which ultimately reduces how much they will net from the sale.

For homebuyers, a 2-1 buydown has several potential benefits. For one thing, it can help them afford a larger mortgage and a more expensive home than they might otherwise qualify for. For another, it buys them some time before their mortgage payments rise to the full amount, which can be helpful if their income is also rising from year to year.

The downside for homebuyers is the risk that their income won’t keep pace with those increasing mortgage payments. In that case, they might find themselves stretched too thin and even have to sell the home.

When to Use a 2-1 Buydown

Home sellers may want to consider offering (and paying for) a 2-1 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 2-1 buydown.

Note that buydowns may not be available under some state and federal mortgage programs or from all lenders. A 2-1 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.

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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