What Is a 1/0 Buydown and How Does It Work?

A mortgage buydown temporarily reduces the interest rate on a home loan, making initial payments more affordable. A 1/0 buydown specifically lowers the borrower’s interest rate for the first year of the loan. Its purpose is to ease the financial burden during the first year, providing reduced payments before the rate adjusts to its permanent level. This temporary reduction can make homeownership more accessible, especially when interest rates are higher.

Understanding the Mechanics of a 1/0 Buydown

A 1/0 buydown uses an upfront payment to temporarily reduce the mortgage interest rate for the first year. The “1” signifies a 1% rate reduction for the first year, while the “0” indicates no reduction for subsequent years. After the initial 12-month period, the interest rate reverts to the original note rate for the remainder of the loan term.

To illustrate, consider a 30-year fixed-rate mortgage with an original interest rate of 7.00%. With a 1/0 buydown, the borrower pays an effective interest rate of 6.00% for the first year. After 12 months, the rate increases to the full 7.00% for the subsequent 29 years. While initial monthly payments are lower, they will increase significantly after the first year. The buydown refers to a lump sum payment made at closing, covering the difference between the lower, temporary interest rate and the actual note rate for that initial period.

Funding a 1/0 Buydown

The cost of a 1/0 buydown is an upfront lump sum payment made at loan closing. This payment subsidizes the reduced interest rate for the first year.

A common source of funding is the home seller, who might offer to pay for a buydown to make their property more attractive to potential buyers, particularly in a slower real estate market or when facing competition. Home builders frequently use 1/0 buydowns as incentives for new construction homes. By offering a temporary reduction, builders make properties more appealing and help buyers manage initial housing costs. Mortgage lenders might also fund a buydown as a promotional offering. The specific party funding the buydown is typically negotiated as part of the purchase agreement or loan terms.

Common Scenarios for Using a 1/0 Buydown

A 1/0 buydown is commonly used in specific market conditions or as a strategic incentive to facilitate property sales. One frequent scenario involves new construction homes, where builders often use these buydowns as a sales tool. By temporarily lowering initial mortgage payments, builders attract buyers hesitant due to affordability or current interest rates.

Another situation for using a 1/0 buydown arises during periods of high interest rates. When mortgage rates climb, a buydown provides temporary relief. This allows buyers to enter the market with a lower initial payment, giving them time to adjust to new financial obligations or potentially refinance if rates decrease. Sellers of existing homes may also offer a 1/0 buydown to stimulate buyer interest and expedite sales, especially when facing extended market times.

Financial Impact on the Borrower

A 1/0 buydown significantly impacts monthly mortgage payments, particularly during the first year. During this initial 12-month period, the borrower benefits from a lower interest rate, resulting in reduced monthly payments compared to the original note rate. This temporary reduction can free up cash flow, potentially allowing the borrower to manage moving expenses or other initial costs.

However, borrowers must understand their monthly mortgage payment will increase after the first year. Once the buydown period concludes, the interest rate reverts to the original, higher note rate for the remaining loan term. Borrowers must be financially prepared for a noticeable jump in their monthly housing expense, as the payment difference can be substantial depending on the loan amount and original interest rate. While initial payments are lower, the total interest paid over the loan’s life is calculated based on the original, un-bought-down interest rate for the majority of the mortgage term.