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Temporary Buydown: 3-2-1 vs 2-1 Comparison


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TERMINOLOGY

A temporary buydown is a mortgage loan option through which a home buyer gets his or her interest payments temporarily reduced for the first few years of the loan repayment period in exchange for an up-front cash deposit. This deposit can be provided by the buyer, the seller or both. The 3-2-1 temporary buydown reduces interest rates for three years, while 2-1 reduces it by two years. A temporary buydown allows home buyers to qualify for mortgage loans they would otherwise be ineligible for. However, the home buyers have to look carefully at the numbers--otherwise, they may wind up paying more than they would have wound up paying if they had taken out a more traditional mortgage.

Understanding Temporary Buydowns

The temporary buydowns are optional parts of the mortgage loan. The mortgage lender can't add it to the mortgage loan unless the home buyer gives his or her explicit consent. The interest rates and other payments are set the same way as they would be with the ordinary mortgage loan, based on the home buyer's income and credit rating, as well as on the size of the mortgage loan. Those interest rates are fixed, so they will remain the same until the loan is repaid. However, with a temporary buydown option in place, those rates are temporarily reduced for a certain period, with the length of the period depending on what type of temporary buydown it is. Aside from the way the interest rates are reduced, those options are identical. The home buyers have an option of choosing whichever option they feel suits them best.

As mentioned above, the temporary buydowns require a lump sum payment. It must be made in full once the loan is signed, and it's often included in the closing costs. That payment usually has to come from the home buyer's own pocket, though there are cases when the home seller may be willing to pay it as an incentive to the home buyer. There are also cases when the buyer and the seller split the payment.

How Interest Rates Are Reduced

In a 3-2-1 temporary buydown, the interest rates are reduced by a progressively smaller amount every year until the interest rates return to the normal level. As the name suggests, the interest rate is reduced by 3 percent during the first year, 2 percent during the second year and 1 percent during the third year. In the fourth year, there are no reductions, and the home buyer has to pay the interest rates in full.

The 2-1 temporary buydown works the same way, except for a shorter period. The interest rates are reduced by 2 percent during the first year and 1 percent during the second year. In the third year, the interest rates return to normal.

Calculating the Best Deal

In order to decide which option suits them best, home buyers must be able to run a few calculations and compare the numbers. First, they must calculate how much money they will have to pay the first five years with a temporary buydown. They will have to do separate calculations for each type of buydown. Then, they must calculate how much they would be paying the first five years without either buydown. Then, for each type of buydown, they must subtract the total interest payments with the buydown from the total interest without the buydown. This number is the money they saved. Then, they should compare the number they got by subtracting a 3-2-1 temporary buydown with a number they got by subtracting a 2-1 temporary buydown. Whichever buydown generated the bigger number is the one they are better off with. And if the money they saved is smaller than the lump sum payment, than they are better off avoiding temporary buydowns altogether.