Can a Borrower Pay for a Temporary Buydown?

A temporary mortgage buydown reduces a borrower’s initial interest rate and monthly payments for a set period. This arrangement helps ease the financial transition into homeownership, allowing borrowers to manage expenses more comfortably during the early years of their loan.

Understanding Temporary Buydowns

A temporary buydown involves placing a lump sum of funds into an escrow account. These funds are systematically drawn upon to supplement the borrower’s monthly mortgage payments for a predetermined duration, typically one to three years. This process effectively lowers the borrower’s out-of-pocket payment during the initial period.

The mortgage features a “note rate,” which is the actual, fixed interest rate for the life of the loan, and a “buydown rate,” which is the temporarily reduced rate the borrower pays during the buydown period. For instance, a common arrangement is a 2-1 buydown, where the interest rate is reduced by 2% in the first year and 1% in the second year, before returning to the full note rate in the third year. Other variations include 3-2-1 buydowns, reducing the rate by 3%, 2%, and 1% over three years, or 1-0 buydowns, offering a 1% reduction for the first year. It is important to note that the borrower must still qualify for the mortgage based on the full, unsubsidized note rate, not the temporarily reduced rate.

Borrower’s Ability to Fund

While temporary buydowns are frequently funded by sellers or home builders as an incentive, borrowers can pay for one. The money typically comes from their own cash reserves or savings. These funds are handled separately from the down payment and other closing costs, and are usually paid as a lump sum at loan closing.

Conventional, FHA, and VA loans permit borrower-funded buydowns, with Fannie Mae and Freddie Mac guidelines allowing for borrower contributions. Unlike interested party contributions, which have specific limits, a borrower’s own funds for a buydown are not subject to these limitations. However, verify specific lender policies, as some may have internal restrictions.

Structuring a Borrower-Funded Buydown

Borrowers funding a temporary buydown deposit the entire amount into a dedicated escrow account. This upfront lump sum payment is in addition to the borrower’s down payment and other standard closing costs. The mortgage lender then manages this account, drawing from it each month to cover the difference between the actual mortgage payment based on the note rate and the temporarily reduced payment the borrower makes.

These buydown funds must be held in a custodial bank account, distinct from the lender’s general operating funds, to ensure proper application. On the Closing Disclosure (CD), a borrower-funded buydown fee is itemized in Section A, detailing origination charges. The projected payments table on the CD illustrates the step-rate payment schedule, showing initial lower payments and subsequent increases. While the buydown agreement dictates the temporary payment schedule, the actual mortgage note reflects the permanent interest rate and terms for the loan’s duration.

Key Considerations for Borrowers

Before funding a temporary buydown, borrowers should assess the financial implications. The entire cost of the buydown fund is paid upfront at closing, representing a significant cash outlay. Borrowers must be prepared for the eventual increase in monthly payments once the buydown period concludes and the interest rate reverts to the full note rate.

Regarding tax implications, the lump sum paid for a temporary buydown is not deductible as an upfront expense in the year it is paid. However, the interest portion of the actual monthly payments made, including both the borrower’s contribution and the subsidy from the escrow account, is deductible as mortgage interest over time. Borrowers should evaluate whether the upfront cost and the temporary payment relief align with their long-term financial goals, considering alternatives like buying points for a permanent interest rate reduction, which offers savings over the entire loan term.