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Interest Rate Buy Downs.... How do they work?

With our market changing we are starting to see interest rate buy downs. We see lender advertisements using the term 3-2-1 or 2-1. What does this mean? We interviewed a lender about this, and this is what we found....


These are considered temporary buy downs. They can be 3-2-1 or 2-1. The 2-1 will likely be offered over the 3-2-1. For a 3-2-1 buydown, the rate for the first year is 3% less than note rate. For the second year the rate is 2% less than note rate. The third year it is 1% less note rate. So if note rate for a 30 year fixed rate mortgage is 6.5%, the first year's payment will be based on a rate of 3.5%. Then 4.5% for year 2, and 5.5% for year 3.

Here is how the payments look based on a $500,000 loan amount:

Year 1 - $2245

Year 2 - $2533

Year 3 - $2838


For a 3-2-1, the full payment based on the 6.5% note rate is $3160. So the cost to the borrower is the difference between the full payment and the yearly discounted payments. So for year 1 that is $10,980. Year 2 is $7523 and Year 3 is $3856. Total cost is the sum of those 3 numbers - $22,358.


For a 2-1 Buydown, it works the same but only 2 years. Year 1 rate will be 2% less than note rate and year 2 will be 1% less. Using the above example again, total cost is $11,379.


What we have seen is the seller will offer to pay for the cost of the buy down in seller concessions. Depending on down payment, concessions can be limited to 3%. That is $19,500 for a $650K purchase price. So the cost of the 3-2-1 buydown exceeds the max concessions allowed. That is a reason many lenders do not offer a 3-2-1. But the 2-1 fits nicely.


Of course, please reach out to the lender you are working with to verify this information. If you need a referral to a lender, let us know! We have a lot of great lenders in our area.

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