What it means
The borrower's loan is a normal fixed-rate mortgage at the full rate from day one. What changes is who pays part of the interest in the first two years, with the escrow deposit covering the gap rather than the lender simply charging less.
The money usually comes from the seller, a housebuilder or occasionally an employer as part of a relocation package. A builder sitting on finished stock often prefers funding a buydown to cutting the headline price, because the discount is cheaper and it does not reset the comparable values of the homes still unsold.
Lenders normally assess affordability at the full rate rather than the reduced first-year rate. That is an important protection: the borrower has to show they can afford the payment that arrives in year three, not just the discounted one they start with.
The arrangement suits a borrower who has a specific, credible reason to expect higher income soon, such as a professional finishing training or a household with a second earner about to return to work. It suits a borrower relying on vague optimism far less well.
The obvious risk is payment shock when the discount ends. A borrower who has built their budget around the year one payment faces two increases in two years, and the second one is permanent.
The main variant is the 3-2-1 buydown, which spreads a larger discount over three years, and there is also the permanent buydown, where upfront points reduce the rate for the whole term. Comparing a temporary buydown with buying permanent points is the calculation most borrowers skip.
In practice
Real-world examples.
Example
A housebuilder with eleven unsold units offers a 2-1 buydown costing about $7,000 per home rather than a $15,000 price reduction. Buyers see a materially lower first-year payment, the builder spends less than half as much, and the published sale prices for the development hold up.
Example
A company relocating a senior engineer includes a 2-1 buydown worth $9,400 in the relocation package instead of a cash bonus of the same size. The benefit arrives as lower monthly outgoings during the move, which is where the pressure on the household budget actually sits.
Example
A hospital doctor two years from the end of her training buys a home with a seller-funded buydown. Her income is contractually due to rise well before the discount ends, so the step up to the full payment in year three is comfortably covered.
Formula
Calculation
Cost of the buydown = 12 x (full monthly payment - year one payment) + 12 x (full monthly payment - year two payment)
Take a $300,000 loan over 30 years at a full note rate of 7%, which gives a monthly principal and interest payment of $1,995.91. In year one the borrower pays at 5%, which is $1,610.46, a saving of 1,995.91 - 1,610.46 = $385.45 a month, so 385.45 x 12 = $4,625.40. In year two the borrower pays at 6%, which is $1,798.65, a saving of 1,995.91 - 1,798.65 = $197.26 a month, so 197.26 x 12 = $2,367.12. The total deposited into escrow is 4,625.40 + 2,367.12 = $6,992.52, and from the start of year three the borrower pays the full $1,995.91 every month.Case study
Seen in the real world.
Marchmont Homes is an illustrative, fictional developer that finished a 40-unit scheme just as mortgage rates climbed and buyer enquiries dried up. Cutting prices by $20,000 a unit would have cost $800,000 across the remaining stock and dragged down the appraisal values supporting the whole scheme.
Instead the sales director funded 2-1 buydowns at roughly $7,000 a unit, a total of about $280,000, and marketed the first-year payment rather than the price. Twenty-six of the remaining units sold within four months.
Marchmont also insisted its preferred lender show every buyer the year three payment in writing and have them sign to confirm they had seen it. The illustrative point is that a buydown is a financing tool and not a discount, so the only responsible way to sell it is alongside the payment that eventually arrives.
Watch out
Common mistakes.
- Believing a 2-1 buydown reduces the interest rate on the loan, when the note rate is unchanged and a third party is simply prepaying part of the early interest.
- Budgeting around the year one payment and forgetting that the full payment arrives in year three and never goes away.
- Taking a buydown without comparing it against permanent points, which can be better value for a borrower who intends to stay for many years.
Questions
People also ask.
Who usually pays for a 2-1 buydown?
Most often the seller or housebuilder as a sales incentive, sometimes an employer in a relocation package, and occasionally the borrower.
What happens to the escrow money if the loan is repaid early?
The unused balance is generally applied to the loan or refunded under the terms of the buydown agreement, rather than being kept by the lender.
Will the lender qualify me at the reduced rate?
Usually not, because affordability is normally assessed at the full note rate, which is the payment you will be making from year three onwards.
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