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Mortgage Buydowns: How Do They Work?

Friday, November 10, 2023   /   by Richard Eimers

Mortgage Buydowns: How Do They Work?

Some homebuyers priced out of the market opt for a mortgage buydown, usually funded by sellers, in order to lower their monthly payments for the first few years

RICHMOND, Va. – Mortgage rates have risen since the Federal Reserve implemented a new monetary policy in 2022, almost hitting 8%. As of Nov. 2, the average 30-year fixed mortgage rate in the U.S. is 7.76%, the highest it’s been in over 20 years.

High interest rates combined with low housing supply have been making the housing market undesirable for buyers and driving down sales activity across the nation. Many potential buyers have been overwhelmed by rising home prices and are put on the sidelines to continue renting. There is a tool called a 3-2-1 mortgage buydown that can incentivize potential homebuyers to buy a home in high interest rate markets.

How does a 3-2-1 mortgage buydown work?

When potential homebuyers are priced out of the market, they can try to get a 3-2-1 buydown mortgage. This type of mortgage reduces the loan interest for the first three years of the loan term. The initial rate will then be applied in the fourth year and continue for the life of the mortgage.

In the first year, the loan is reduced by 3%, by 2% in the second year and 1% in the third year. For example, if a homebuyer bought a home at a 7.76% mortgage rate in the first year of the loan, the rate would be 4.76% the first tear, 5.76% the second year, and 6.76% the third year.

The cost of a 3-2-1 buydown mortgage is the total amount that the buyer saves over the three-year period of lower rates.

Usually, this type of mortgage is used by sellers or home builders to help ease the costs for buyers. Sometimes, a company would cover the buydown cost when relocating an employee to a new city to help with expenses. Buydown mortgages are only used for primary and secondary homes, not investment properties. The lender must still qualify the homebuyer at full interest rate before implementing this tool.

Buydowns increase when interest rates go up

Towards the second half of 2022, the share of temporary mortgage buydowns surged when rates increased to over 6%. Temporary buydowns were controlled among a few non-bank lenders in the last year. Between June 2022 and 2023, just 12 lenders managed 80% of all temporary buydowns in the nation, according to Freddie Mac.

In recent months, temporary buydowns have been trending down compared to last year. This data can be used to analyze the willingness homebuyers have to take high interest rates.

3-2-1 mortgage buydowns have become more common for financing newly built homes because home builders usually work together with mortgage companies to negotiate the price and rates. Potential homebuyers who want to use this financial option must understand that in the fourth year, the mortgage will go up to its original rate and evaluate their finances before closing to make sure they can afford it when the time comes.

Source: Virginia Association of Realtors

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Beach Road Realty
Richard Eimers
17 Roundwood Drive
Inlet Beach, FL

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