Exploring Temporary Buydowns: 2-1 and 3-2-1 Buydowns Explained

Exploring Temporary Buydowns: 2-1 and 3-2-1 Buydowns Explained

In a previous discussion, we explored permanent rate buy downs, where you pay a one-time fee to secure a permanently lower interest rate. Now, let's delve into a different strategy: temporary buy downs, specifically 2-1 and 3-2-1 buy downs. These methods can offer significant savings on your mortgage payments during the initial years of your loan.

What is a Temporary Buydown?

A temporary buydown is a financing arrangement where the seller provides a credit to reduce your interest rate for the first few years of the mortgage. Unlike a permanent buydown, the rate reduction is temporary, and your interest rate will eventually rise to the original fixed rate. Here’s how they work:

• 2-1 Buydown: Your interest rate is reduced by 2% in the first year and 1% in the second year. By the third year, the rate returns to the standard fixed rate.
• 3-2-1 Buydown: Your interest rate is reduced by 3% in the first year, 2% in the second year, and 1% in the third year. By the fourth year, the rate returns to the standard fixed rate.

Practical Example: 2-1 Buydown

Imagine you’re looking at a $300,000 home and considering making an offer. Instead of negotiating a lower purchase price, you might request a seller credit to apply towards a 2-1 buydown.

• Home Price: $300,000
• Standard Interest Rate: 7.5%
• Monthly Payment at Standard Rate: $2,600
• Offer with Price Reduction: $285,000
• Monthly Payment with Price Reduction: $2,470

Alternatively, you could keep the price at $300,000 and request a $15,000 seller credit to cover closing costs and fund a 2-1 buydown.

• First Year Interest Rate: 5.5%
• First Year Monthly Payment: $2,213
• Second Year Interest Rate: 6.5%
• Second Year Monthly Payment: $2,406
• Third Year Onwards Interest Rate: 7.5%
• Third Year Onwards Monthly Payment: $2,600

In this scenario, you save $387 per month in the first year and $194 per month in the second year, totaling significant savings during the initial years of your mortgage.

Practical Example: 3-2-1 Buydown

Now, let’s consider a 3-2-1 buydown with the same home price and interest rate.

• First Year Interest Rate: 4.5%
• First Year Monthly Payment: $1,988
• Second Year Interest Rate: 5.5%
• Second Year Monthly Payment: $2,213
• Third Year Interest Rate: 6.5%
• Third Year Monthly Payment: $2,406
• Fourth Year Onwards Interest Rate: 7.5%
• Fourth Year Onwards Monthly Payment: $2,600

With a 3-2-1 buydown, you save $612 per month in the first year, $387 per month in the second year, and $194 per month in the third year.

Why Choose a Temporary Buydown?

Temporary buydowns can be an excellent strategy for several reasons:

1. Lower Initial Payments: They provide lower mortgage payments during the initial years, which can help you adjust to your new financial responsibilities.
2. Flexibility: If you plan to refinance or sell your home within a few years, a temporary buydown can save you money without locking you into a higher upfront cost.
3. Seller Credits: You can negotiate seller credits to fund the buydown, reducing your cash-to-close and overall initial expenses.

The Safety Net

One of the unique benefits of a temporary buydown is that the funds used to reduce the interest rate are held in an escrow account. If you refinance or sell your home before the temporary buydown period ends, any remaining funds in this account are returned to you. This feature provides a safety net, ensuring that your investment in the buydown isn't lost.

Conclusion

Temporary buydowns, such as 2-1 and 3-2-1 buydowns, offer a compelling option for homebuyers looking to manage their initial mortgage payments effectively. By negotiating seller credits to fund these buydowns, you can enjoy lower payments during the early years of your loan and retain flexibility for future refinancing or selling. If you’re a first-time homebuyer or navigating a high-interest rate environment, these strategies could provide the financial relief you need to comfortably afford your new home. Always consult with your mortgage advisor to see if a temporary buydown aligns with your financial goals and circumstances.