What Is a 321 Buydown and How Does It Work?

A 3-2-1 buydown is a mortgage financing strategy designed to make homeownership more accessible by temporarily reducing early mortgage payments. It eases the financial burden for borrowers during the initial years of their loan term. This strategy functions by modifying the interest rate applied to the mortgage for a set period, impacting the monthly payment amount.

Defining a 321 Buydown

A 3-2-1 buydown involves a temporary reduction in the interest rate on a mortgage for the first three years. The “3-2-1” signifies the percentage points by which the interest rate is lowered each year: 3% in the first year, 2% in the second, and 1% in the third, compared to the loan’s permanent rate. After this three-year period, the interest rate reverts to the full, original rate for the remainder of the loan term. This temporary structure provides borrowers with more manageable monthly payments initially.

This financing tool differs from traditional discount points, which reduce the interest rate for the entire life of the loan. A 3-2-1 buydown is a short-term measure, offering a graduated payment schedule that gradually increases. It can be appealing when initial interest rates are high, offering a temporary reprieve from elevated payment amounts. Borrowers must be prepared for the eventual increase in their monthly payments.

Mechanics of a 321 Buydown

The operation of a 3-2-1 buydown involves a stepped interest rate reduction schedule. For example, if a mortgage has a permanent interest rate of 7%, a 3-2-1 buydown would temporarily lower the rate to 4% in the first year, 5% in the second, and 6% in the third.

To facilitate these reduced payments, a lump sum is deposited into a dedicated “buydown fund” or escrow account at the loan closing. This fund subsidizes the borrower’s monthly payments during the buydown period. Each month, the lender draws from this escrow account to cover the difference between the temporarily reduced payment made by the borrower and the actual payment due at the full, permanent interest rate. The total payment received by the lender, combining the borrower’s contribution and the escrow withdrawal, remains consistent with the full loan payment.

The party responsible for funding this lump sum deposit varies. Most often, the home seller or home builder pays for the buydown as an incentive to attract buyers or expedite a sale. In some instances, the mortgage lender may also contribute to the cost of the buydown.

Financial Aspects and Stakeholders

The cost of a 3-2-1 buydown is the lump sum deposited into the escrow account. This amount equals the total interest savings the borrower realizes over the three-year buydown period. The calculation involves determining the difference between the monthly payment at the full interest rate and the reduced payment, then summing these differences over three years.

If a borrower refinances or sells the home before the three-year buydown period ends, any unused funds remaining in the escrow account are typically credited back to the party who initially funded the buydown, or applied towards the loan’s principal balance. In some cases, if the borrower refinances, these funds may also be applied towards the new loan’s closing costs.

Various stakeholders participate in a 3-2-1 buydown. For the buyer, the primary financial aspect is the temporary reduction in monthly mortgage payments, which can make homeownership more affordable in the initial years. This reduced financial outlay can assist with other early homeownership expenses like moving costs or furniture purchases. For sellers or builders, offering a 3-2-1 buydown serves as a powerful incentive to attract potential buyers, particularly when market interest rates are high or when selling new construction homes. This strategy can help them achieve their asking price without direct price reductions. Lenders play a role in administering the buydown, managing the escrow account, and ensuring the proper application of funds to subsidize payments.