A reduction in the mortgage payment made by a homebuyer in the early years of the loan in exchange for an upfront cash deposit provided by the buyer, the seller, or both.
How Temporary Buydowns Work: Temporary buydowns are a tool for borrowers purchasing a home who don't have enough income, relative to their monthly mortgage payment and other expenses, to meet lender requirements. To use a temporary buydown, the borrower must have access to extra cash. The cash can be the borrower's or it can be contributed by a home seller anxious to complete a sale. The cash funds an escrow account from which the payments that supplement the borrower's payments are drawn.
While the borrower's payments are reduced in the early years, the payments received by the lender are the same as they would have been without the buydown. The shortfalls from the borrower are offset by withdrawals from the escrow account.
Temporary buydowns are not a type of mortgage. They are an option that can be attached to any type. Most temporary buydowns, however, are attached to fixed-rate mortgages.
Temporary Versus Permanent Buydowns: Another way in which borrowers with excess cash can reduce their mortgage payment is by paying additional points in order to reduce the interest rate. This is sometimes called a “permanent buydown” because the reduced payment holds for the life of the loan. For the same number of dollars invested, however, temporary buydowns reduce the monthly payment in the first year, which is the payment used to qualify the borrower, by a larger amount than a permanent buydown. This reflects the concentration of the payment reduction in the early years of the loan.
The table illustrates the three most common temporary buydowns. On a 3-2-1 buydown, the mortgage payment in years one,
two, and three is calculated at rates 3%, 2%, and 1%, respectively, below the rate on the loan. On a 2-1 buydown, the payment in years one and two is calculated at rates 2% and 1% below the loan rate. And on a 1-0 buydown, the payment in year one is calculated at 1% below the loan rate.
The 3-2-1 buydown involves the largest reduction in the borrower's payment in the first year, but also requires the largest amount placed in escrow, as shown on the bottom line.
The required escrow shown in the table assumes that no interest is paid on the account. If the borrower were credited with 4% interest on the 3-2-1 illustrated above, the required deposit to the buydown account would fall from $4,586 to $4,369. Only a few lenders credit interest, however.
Some lenders not only do not pay interest on the buydown account, but dispense with the account altogether, replacing it with additional points equal to the sum of the buydown digits. That is, they charge an additional 6 points for a 3-2-1, 3 points for a 2-1, and 1 point for a 1-0. This is a ripoff.
Calculator 7d on my Web site will allow you to experiment with a variety of temporary buydown options that are available in the marketplace. In general, you will want the smallest buydown you need to qualify. The calculator will also show you the proper deposit to escrow for any buydown.
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