In a temporary buydown, the loan’s interest rate is lowered for a specific period, and then it gradually increases to the original rate specified in the loan agreement. There are a few common structures for temporary buydowns:

1. 3-2-1 Buydown: The interest rate is reduced by 3% in the first year, by 2% in the second year, by 1% in the third year, and then it returns to the full rate for the remainder of the loan term.
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3. 2-1 Buydown: The interest rate is reduced by 2% in the first year and by 1% in the second year, then returns to the full rate in the third year.
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5. 1-0 Buydown: The interest rate is reduced by 1% in the first year, and then it returns to the full rate starting in the second year.
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Example of a 2-1 Buydown

Let’s say a borrower takes out a $300,000 mortgage with a 6% fixed interest rate. Under a 2-1 buydown:

• Year 1: The interest rate is 4% (2% lower than the original rate). The monthly payment is based on this reduced rate.
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• Year 2: The interest rate is 5% (1% lower than the original rate). The monthly payment increases but is still lower than it would be at the full rate.
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• Year 3 onward: The interest rate resets to the original 6%, and the borrower makes payments based on this rate for the remainder of the loan term.

How the Buydown is Funded

The cost of the buydown is typically paid upfront by the borrower, seller, builder, or lender. The amount paid covers the difference between what the borrower would have paid at the original interest rate and what they pay at the reduced rate during the buydown period. For example, in a 2-1 buydown, the total buydown cost is the sum of the interest savings from the first two years.

Why Borrowers Use Temporary Buydowns

• Lower Initial Payments: A temporary buydown allows borrowers to ease into their mortgage payments, which can be especially helpful if they expect their income to increase in the near future.
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• Affordability: It can make a home more affordable in the short term, which is beneficial for buyers who might be stretching their budget to purchase a home.
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• Market Strategy: Sellers or builders may offer a temporary buydown as an incentive to attract buyers, especially in a slow real estate market.
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Why Lenders Agree to Temporary Buydowns

• Attracting Borrowers: Temporary buydowns can make loans more attractive to borrowers, particularly in high-interest-rate environments, which helps lenders increase their loan origination volume.
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• Risk Mitigation: Although the lender receives lower payments initially, they are typically compensated through the buydown fund that covers the difference. Once the temporary period ends, the lender receives the full interest rate on the loan.
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• Third-Party Funding: When sellers or builders pay for the buydown, the lender faces less financial risk since the cost is covered by the third party, making it easier for them to offer such products.
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A temporary buydown lowers the borrower’s interest rate and monthly payments for a limited time, providing short-term affordability. The cost is typically covered upfront, often by a seller or builder, making it a useful tool in real estate transactions to make homes more appealing to buyers.