Understanding temporary rate buydowns
What is a temporary buydown?
A temporary buydown reduces the borrower's effective interest rate and monthly principal and interest (P&I) payment during the initial 1 to 3 years of a fixed-rate loan.
- 3-2-1 buydown: Rate is reduced by 3% in Year 1, 2% in Year 2, and 1% in Year 3. Standard note rate begins in Year 4.
- 2-1 buydown: Rate is reduced by 2% in Year 1 and 1% in Year 2. Standard note rate begins in Year 3.
- 1-1 buydown: Rate is reduced by 1% in Year 1 and 1% in Year 2. Standard note rate begins in Year 3.
- 1-0 buydown: Rate is reduced by 1% in Year 1. Standard note rate begins in Year 2.
Who funds a temporary buydown?
Temporary buydowns are typically funded by an upfront lump-sum escrow deposit paid at closing by the seller, home builder, or lender.
How is the cost calculated? (Worked example)
Total buydown cost equals the exact sum of all monthly payment savings over the buydown period. For a 30-year fixed loan of $400,000 at a 6.5% note rate (standard payment of $2,528.27/mo) with a 3-2-1 buydown:
- Year 1 (3.5% rate): Monthly payment is $1,796.18, saving $732.09/mo ($8,785.12 annually).
- Year 2 (4.5% rate): Monthly payment is $2,026.74, saving $501.53/mo ($6,018.37 annually).
- Year 3 (5.5% rate): Monthly payment is $2,271.16, saving $257.12/mo ($3,085.39 annually).
- Years 4–30 (6.5% note rate): Monthly payment returns to the standard $2,528.27.
Total escrow cost funded at closing: $17,888.88 ($8,785.12 + $6,018.37 + $3,085.39).