3-2-1 Buy-Down Mortgage permits a borrower to decrease the interest rate over the course of the first three years of the loan by making a prepayment. In general, 3-2-1 buy-down loans are only available for first and second homes, while investment properties are ineligible. The 3-2-1 buy-down is also not available as part of an Adjustable-Rate Mortgage (ARM) with an initial term of less than five years.
Look at a glance
— A 3-2-1 buy-down mortgage permits the lender to decrease the interest rate on a mortgage for the first three years of repayment.
— In return for an advance payment, the loan interest is reduced by 3 percentage points in the first year, by 2 percentage points in the second year and by 1 percentage point in the third year to a base rate.
— After the purchase period has expired, the mortgage reverts to a fixed-rate loan at the base rate.
— These loans are designed to help new home buyers afford a property, with lenders or sellers being able to subsidize part of the purchase price payment.
How 3-2-1 Buy-Down Mortgages Work
A buy-down or buyout is a method of mortgage financing that allows the buyer to obtain a lower interest rate by paying upfront for at least the first few years of the mortgage or possibly its entire life cycle. Much like a borrower buying rebate points on a mortgage, it is a type of temporary grant buyback. With an additional down payment on completion, the borrower temporarily acquires a lower interest structure. A 3-2-1 buyback mortgage reduces the lending rate by 3% in the first year, 2% in the second, and 1% in the third. There is a fixed interest rate for the remaining term of the loan. This is comparable to a 2-1 buy-down, in which the price is reduced by two points in the first year, by one point in the second year and then back to the set price after the purchase period has expired.
The 3-2-1 buyout can be an attractive option for a buyer with cash at the beginning of the loan. It is also suitable for borrowers who expect higher income in the years to come. In the first three years with lower interest charges and thus lower monthly payments, the borrower can set aside money for other expenses.
As with a 2-1 buy-down, the interest rate is reduced to a permanent interest rate at the end of the third annual reduction. This fixed interest rate offers the borrower some financial security and allows budgeting. At this point, the 3-2-1 becomes a traditional loan and offers stability, especially when compared to an adjustable-rate mortgage or an adjustable-rate mortgage (ARM). These two long-term variable interest rate products expose the buyer to significant interest rate risk over the life of the loan. Unstable interest rates also increase the likelihood that the borrower will ultimately have to refinance the bond.
Subsidized 3-2-1 Buy-Downs
In some situations, the 3-2-1 offer can act as an incentive if the buyout is paid by a third party. The third party could be the seller willing to buy a cash-refund from the buyer to sell a property. In other cases, a company that relocates an employee to a new market may pay acquisition costs to reduce the costs of relocating that employee. More often than not, a builder offers to subsidize the construction of a new home by agreeing to purchase the temporarily lower interest rates as an incentive for the buyer of a new home.
The lender would receive the same mortgage payments as they would have received on a traditional loan. In the case of a grant, however, the builder, seller or employer also pays an amount equal to the discounted monthly payments made by the borrower during the first three years of a loan.