What Is a 3-2-1 Buy-Down Mortgage?

A 3-2-1 buy-down mortgage allows a borrower to lower the interest rate over the course of the first three years of the loan through an up-front payment. In general, 3-2-1 buy-down loans are only available on primary and secondary homes, while investment properties are not eligible. The 3-2-1 buydown is also not available as part of an adjustable-rate mortgage (ARM) with an initial period of fewer than five years.

Key Takeaways

  • 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
  • In return for an up-front payment, the loan interest is reduced by 3 percentage points in the first year, 2 in the second year, and 1 in the first year, off of some base interest rate.
  • After the buydown period ends, the mortgage reverts to a fixed interest loan at the base interest rate.
  • These loans are intended to help new homebuyers afford a property, where lenders or sellers may subsidize a portion of the buydown payment.

How 3-2-1 Buy-Down Mortgages Work

A buydown is a mortgage-financing technique where the buyer is able to obtain a lower interest rate for at least the first few years of the mortgage, or possibly its entire life buy providing an up-front payment. It is similar to the practice of a borrower buying discount points on a mortgage 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. This can be compared with a 2-1 buydown where the the rate is lowered by two points during the first year, by one in the second year, and then goes back to the settled rate after the buydown period expires.

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. 

As with a 2-1 buydown, at the end of the third year reduction the interest rate resets to a permanent interest rate. This fixed 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.

Subsidized 3-2-1 Buy-Downs

In some situations, the 3-2-1 offer may come as an incentive with the buydown paid by a third party. The third party could be the 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.