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

A 1-0 buydown is a type of temporary interest rate reduction applied to a mortgage for the first year of the loan. This financing option aims to make the initial mortgage payments more affordable for homebuyers. It provides a period of reduced payments, which can ease the financial transition into homeownership. This temporary adjustment helps manage costs at the beginning of the loan term.

Understanding the Mechanics

A 1-0 buydown specifically functions by lowering the effective interest rate for the initial 12 months of the mortgage. The “1” in “1-0” signifies a one percentage point reduction in the interest rate for the first year. Conversely, the “0” indicates that there is no further reduction, meaning the interest rate reverts to the original, agreed-upon rate for all subsequent years of the loan term.

To illustrate, if a borrower secures a mortgage with an original interest rate of 7%, a 1-0 buydown would reduce the effective interest rate to 6% for the first year. This temporary adjustment is applied directly to the loan’s original interest rate, not to the principal balance. The fundamental terms of the loan, such as the total loan amount and the overall loan duration, remain unchanged.

Funding Sources and Implications

The funds necessary to cover the cost of a 1-0 buydown are typically provided by a third party. This cost represents the difference between the interest accrued at the original note rate and the interest accrued at the temporarily reduced rate during the buydown period. Common entities that fund these buydowns include the home seller, the home builder, or, in some instances, the mortgage lender.

These parties often offer a buydown as an incentive to facilitate a sale, particularly in competitive or fluctuating market conditions. For example, a builder might offer a buydown to attract buyers to a new development, or a seller might use it to make their property more appealing. The funds for the buydown are not given directly to the borrower. Instead, they are usually placed into an escrow account at the time of closing.

From this escrow account, a portion of the funds is disbursed monthly to the lender. This disbursement covers the difference between the interest payment calculated at the original, higher rate and the payment made by the borrower at the reduced rate. This mechanism ensures that the lender receives the full interest amount due on the loan, while the borrower benefits from the lower monthly payment.

Impact on Mortgage Payments

A 1-0 buydown directly influences a borrower’s monthly mortgage payments, creating a distinct payment schedule. During the first year, the monthly payments will be lower than they would have been at the original interest rate, due to the temporary rate reduction. This reduction can provide immediate financial relief, potentially freeing up funds for other expenses associated with new homeownership, such as moving costs or initial home improvements.

Consider a hypothetical 30-year fixed-rate mortgage for $350,000 at an original interest rate of 7.375%. With a 1-0 buydown, the effective interest rate for the first year would be 6.375%. This reduction could lower the monthly principal and interest payment from approximately $2,417 to $2,184, resulting in a monthly saving of about $233 during that first year.

After the initial 12-month period concludes, the interest rate automatically reverts to the original, higher rate agreed upon in the mortgage contract. Consequently, the borrower’s monthly mortgage payments will increase to the amount calculated at that original rate for the remainder of the loan term. Borrowers should understand and financially prepare for this payment adjustment, as the increase can be significant depending on the loan amount and interest rates.