A 3-2-1 mortgage buydown is an option for home buyers who have relatively low incomes but possess lump sums of cash. With a 3-2-1 buydown, buyers will experience lower initial payments for the first three years than with a traditional mortgage.

The interest rate on a  3-2-1 buydown is reduced 3% below the note rate and incrementally raised 1% each year for three years until it reaches the note rate, where it remains for the life of the loan. A 3-2-1 buydown is based on a 30-year fully amortized mortgage.

If the interest rate on the mortgage for which you applied is 6.5%, you could “buydown” your interest rate to 3.5% for the 1^st year, 4.5 % for the 2^nd year and 5.5% for the 3^rd year. By the end of the 3^rd year, your interest rate would be 6.5% from year four until the loan closes. In a conventional mortgage, you would pay 6.5% interest from day one until the loan closes instead of the reduced amount. The difference between what you should have paid with a conventional mortgage and what you actually paid with a 3-2-1 buydown must be paid initially in the form of extra points.

Example: With a 30-year fixed $250,000 mortgage at a 6.5% interest rate, it would cost you or the seller $11,160 in a 3-2-1 buydown mortgage situation. This is what the payment schedule would look like:

First year payments at an interest rate of 3.5% = $1,123/ month
Second year payments at an interest rate of 4.5% = $1,267 / month
Third year payments at an interest rate of 5.5% = $1,420 / month
Fourth year through 30th year at an interest rate of 6.5% = $1,580 / month

Now compare the payment with a conventional mortgage of 6.5% (payments would be $1,580) with the reduced amounts.

The savings for the first year = $1,580 – $1,123 = $457 / month or $5,484 / year
The savings for the second year = $1,580 – $1,267 = $313 / month or $3756 / year
The savings for the third year = $1,580 – $1,420 = $160 / month or $1,920 / year

The total savings over the three years of reduced payments equates to $11,160 ($5,484 + $3,756 + $1,920). Therefore, it will cost approximately $11,160 to buy down the mortgage payment and the interest rate for the three years.

3-2-1 Buydown vs. Graduate Payment Mortgages

A 3-2-1 buydown is similar to a graduated payment mortgage in that the payments start low and gradually increase until a maximum is reached. This maximum payment is continued throughout the life of the loan.

Note: A buyer may desire a 3-2-1 buydown but if he/she does not possess the cash to pay the extra points required to “buydown” the mortgage, upon negotiation, some sellers will be willing to pay the points.

The difference between a GPM and a 3-2-1 mortgage buydown:

• With a 3-2-1 buydown, in order to offer lower payments initially and maintain a reduction in principal, higher points must be paid at the onset of the loan.
• A GPM uses negative amortization during the initial phases, which increases the principal over time until the maximum payment is reached. In a 3-2-1 buydown, the principal and interest is covered in the payment so the principal is decreasing every month.
• Lenders may require a down payment at least 10% for a 3-2-1 mortgage buydown.

The 3-2-1 mortgage buydown is a great option for buyers who see their income increasing in the near future. With extra cash, a 3-2-1 buydown is also a good choice for buyers who do not want to take part in a negative amortization loan but they need a reduced payment initially. Speak to a mortgage professional about which option works best for you and for your current financial situation.