Aug 14, 2017
A temporary buydown is a loan program that allows a buyer to pay a reduced interest rate (and payment) the first few years of his mortgage. A buydown uses money from the seller or lender to pay a portion of the buyer's mortgage payment. Therefore, it appears to "buy down" the interest rate.
In reality, it doesn't change the interest rate or "note" rate for the loan. But the payment the first few years is based on a lower rate while being subsidized by the seller or lender.
Let's look at an example. (Interest rates used for this exercise are for illustration purposes only and are not representative of an interest rate actually available on any given day.)
This is an example of a 2-1 buydown. The interest rate is discounted by 2% the first year and 1% the second year. It then returns to the original note rate the third year.
There is also a 1-1-1 buydown. In this scenario, the interest rate is discounted by 1% each year for the first three years before returning to the original note rate.
Buydowns can also be funded by the lender in exchange for a slightly higher interest rate. Lender funded buydowns are only available as 1-0 buydowns (interest rate is discounted by 1% the first year before returning to the original note rate). However, lender funded buydowns are only a good idea in a few very specific circumstances.
Lender funded buydowns require the borrower to pay a higher interest rate after the first year. Most of the time, it's not worth having a lower payment the first year only to have a higher payment for the next 29 years! Therefore, most people who choose lender funded buydowns plan to pay off or pay down the mortgage substantially during the first year. Or a borrower might have a reasonable expectation that her income would increase after the first year of home ownership.
Buydowns are avilable on Fannie Mae, FHA, and VA purchases (and Fannie Mae refinances). The program is only available with 30-year fixed rate mortgages. All down payment options are eligible for buydowns.
Buyers must qualify using the note rate (not the discounted rate). So the program can't be used to qualify for a large loan.
Buydowns are not available on non-owner occupied transactions (investment properties).
Buydowns are a great idea for sellers! By offering to fund a temporary buydown for potential buyers, sellers set their home apart from similar listings in their neighborhood.