3-2-1 Buy-Down Mortgage

A 3-2-1 buy-down mortgage refers to a type of mortgage which allows the borrower to lower the interest rate over the first three years through an up-front payment. In general, 3-2-1 buy-down loans are only available on primary and secondary homes. Investment properties are not eligible. Nor are they available as part of an adjustable-rate mortgage (ARM) with an initial period of fewer than five years.

A 3-2-1 buy-down mortgage allows the lender the lower the interest rate of a mortgage over the first three years of repayment. It is similar to the practice of a borrower buying discount points on a loan and is one type of temporary subsidy buydown. By making an additional down payment at closing, the borrower purchases, temporarily, a lower interest rate structure. In a 3-2-1 buy-down mortgage, the loan’s interest rate is lowered by 3 percent in the first year, 2 percent in the second and 1 percent in the third. A permanent interest rate exists for the remaining term of the loan.

The 3-2-1 buy-down can be an attractive option to a homebuyer with available cash at the outset of the loan. It is also suitable for those borrowers who expect higher income in future years. Over the first three years of lower interest charges and as a result lower monthly payments, the borrower can set aside cash for other expenses. 

At the end of the third year reduction, the interest rate resets to a permanent interest rate. This steady rate offers the borrower a degree of financial security and allows for budgeting. At this point, the 3-2-1 becomes a conventional loan and provides stability, especially when compared to a variable-rate mortgage or adjustable rate mortgage (ARM). These two products with long-term moving interest expenses expose buyers to significant interest rate risk over the life of the loan. Unstable interest also increases the likelihood that the borrower will eventually need to refinance the note.

In some situations, the 3-2-1 buy-down may come as an incentive with the buydown coming from a third party. The third party could be a seller, willing to give a cash refund to the buyer in the form of the buydown in order to sell a property.

In other cases, a company moving an employee to a new market might cover the buydown cost to ease the costs of relocation for that employee. More commonly, a builder offers to subsidizes a new home construction by agreeing to buy the temporarily lower interest rates as an incentive to the buyer of a new home. 

The financial lending institute would receive the same mortgage payments that it would have received via a conventional loan. However, with a subsidy, the builder, seller, or employer will also contribute an amount equal to the borrower’s discounted monthly payments in the first three years of a loan.