Temporary rate buydowns: how a 2-1 buydown works

Common structures

Buydowns are named by how many percentage points the rate is reduced in each year:

• 1-0: one point lower in year one, then the full rate.
• 2-1: two points lower in year one, one point lower in year two, then the full rate.
• 3-2-1: three, two and one points lower in years one to three, then the full rate.

Fannie Mae's rules set the outer limits for loans it buys: the reduction cannot exceed 3 percentage points, the rate you pay cannot rise by more than 1 point a year, and the buydown period cannot be longer than three years. Buydowns are allowed on fixed-rate loans and certain adjustable-rate plans for principal residences and second homes. They are not allowed on investment properties or cash-out refinances.

Who pays, and the limits

The fund can come from the seller, a builder, the lender or the buyer. When it comes from an interested party such as the seller or builder, Fannie Mae counts it as an interested party contribution, so it shares the same cap as any closing cost credits the seller gives you. That cap depends on your down payment and occupancy; the interested party contributions guide in the Selling Guide lists the limits.

Fannie Mae requires a written buydown agreement between whoever provides the funds and the borrower. All its terms must be disclosed to Fannie Mae, the mortgage insurer and the appraiser. The money must sit in a custodial account, separate from the lender's own funds.

Not every program allows buydowns. USDA's guaranteed loan rules, for example, list "establishing a buydown account" among the uses of loan funds that are not allowed. Ask your lender what your loan type permits.

You qualify at the full rate

This is the most important rule for your budget. Fannie Mae requires lenders to qualify you based on the note rate, without considering the bought-down rate. In the example, the lender checks that the buyer can afford $2,023 a month plus taxes and insurance, not $1,621.

That protects you, but it also means a buydown does not help you qualify for a bigger loan. Its value is cash flow in the early years: money to furnish the house, cover moving costs or build savings.

The buydown agreement must also state that you are not relieved of making the payments required by the note if the buydown funds are unavailable for any reason.

Selling or refinancing early

If you sell or refinance before the buydown period ends, there may be money left in the fund. Fannie Mae allows the agreement to provide for unused funds to go back to the borrower, or to the lender if it funded the buydown. Read your agreement so you know which applies.

Buydown, price cut or permanent points?

A seller who is willing to spend $7,283 could instead cut the price or pay permanent discount points. Compare:

• Temporary buydown: big savings early, none later. Useful if you expect income to rise or want cash in the first two years.
• Price cut: lowers the loan for its whole life and lowers your down payment slightly. The monthly effect is small; on a 30-year loan at 6.5%, $7,283 less principal saves about $46 a month.
• Permanent points: the CFPB explains points lower your rate for the life of the loan in exchange for paying upfront. They suit buyers who will keep the loan for many years.

If you might refinance soon after rates fall, a permanent rate cut you pay for now may be wasted, while a temporary buydown delivers its savings early.

Planning for the step-ups

Write down the date each payment increase takes effect. Set up your budget, and automatic payments if you use them, for the higher amount in advance. A good habit is to save the difference during the buydown years, so the full payment never feels like a shock.

The bottom line

A temporary buydown cuts your rate for one to three years using money set aside at closing, often from the seller or builder. You still qualify at the full note rate and must be able to afford it. Compare the same dollars as a price cut or permanent points, read the buydown agreement for early-payoff terms, and plan for each step-up before it arrives.