What is a "buydown?"

A buydown, or temporary interest rate buydown, is a mortgage program that offers the borrower a lower interest rate in the beginning years of a mortgage, and a fixed rate for the remainder of the mortgage.

The most popular of the buydowns is a 2-1-0 Buydown. With this program, the interest rate is 2% below the note rate in year one, 1% below the note rate in year two, and the note rate for years 3-30 of the mortgage.

In order to get the reduced rates for the initial years, a buydown subsidy account is established. At closing, money is deposited in this account in an amount equal to the differences in payment in the initial years. Below is an example:

Assume the note rate on a $100,000 mortgage is 6% for 30 years. With a 2-1-0 Buydown the rate would be 4% in year one, 5% in year two, and 6% for the remaining 28 years.

Year 1 Payment (@4%) = $477.42
Year 2 Payment (@5%) = $536.82
Year 3-30 Payment (@6%) = $599.55

The difference in payments for year one is $122.13 per month or $1,465.56 per year.
The difference in payments for year two is $62.73 per month of $752.76 per year.
The total difference in payments for both years is $2,218.32.

So, a buydown subsidy account in the amount of $2,218.32 would be established at closing. Each time a payment is made money from the buydown subsidy account is withdrawn to make up for the payment difference.

As you can see, there is a big savings in the first two years which would allow the borrower to qualify for a larger mortgage. It is also useful for a borrower who now their income will be increasing in the future. It is very popular with people who are relocating for work. They have a new job but their spouse will need to find a job when they get to their new home. This gives them time with a lower payment.

The problem for most people is the amount of money needed for the buydown subsidy. There are several ways to put money into this account. The borrower can pay cash at closing, the borrower can negotiate for the seller to pay for the subsidy, or the borrower can roll the costs into their mortgage on a refinance, or the borrower can opt for a higher note rate that will give them a credit to pay part or all of the subsidy.