How a 3-2-1 Buy-Dow Mortgage Works

By paying a larger sum up-front, mortgage buyers can enjoy lower interest rates for the first three years of a home loan. This is called a buy-down, and paying an additional cash amount during the closing process allows you to pay less interest and reduce the loan's long-term costs.

Mortgage buy-downs are categorized as permanent and temporary, such as the 3-2-1 since it works out over three years. A permanent mortgage buy-down allows you reduced interest rates for the entire loan term. A lower rate, which is usually 3% of the permanent interest rate, is charged for the first year of your loan payments. For the second and third year, rates are 2% and 1% lower than the note rate.

3-2-1 buy-down options are an attractive incentive for homebuyers with an available amount of extra cash during the loan's initial period. If you expect your income to increase in future years, or there are other expenses soon after buying your home, this repayment plan gives you graduated rates kept low at the onset.

Example of a 3-2-1 Buy-Down Mortgage

You apply for a mortgage loan and, based on your credit score plus other factors, qualify for a 6% interest rate. Maybe you need to make some adjustments or renovations in the property for the first few years, and you, therefore, anticipate extra expenses.

To reduce the mortgage payments, you'll pay an additional pre-agreed amount above your closing value, taking advantage of a 3-2-1 arrangement that accomplishes your short-term savings goals. In essence, the interest rate, which by extension reflects on your monthly payments, will be reduced to look like:

  • 3% interest for the first 12 months or 6% minus 3%
  • 4% interest for the second 12 months or 6% minus 2%
  • 5% interest in the third year or 6% minus 1%
  • 6% interest for the remaining loan term

The designation 3-2-1 is derived from how much interest rate is reduced, reverting to the pre-set rate the lender assigned you after the third year. With this in mind, you'll be able to calculate how much you can save during those three years, the key being not to overpay the initial additional closing amount.

Significance of a 3-2-1 Buy-Down Mortgage

By calculating the buy-down's total cost, you can save on the interest rate's reduction with the 3-2-1 mortgage repayment plan. Third parties or even home sellers can use this buy-down as an incentive to get customers interested in their properties.

An additional closing amount that kickstarts a graduated interest rate reduction can come from a company moving an employee to new market locations and looking to ease the transition. Builders can offer the temporary low repayments as incentives to subsidize new homes, meaning the lender still gets the same payments as with a conventional loan.

These subsidies are paid by the employer, builder, or home seller and will equal the discounted payments that the borrower saves during the first three years of the mortgage. After the first three years, interest rates remain fixed for the rest of your mortgage loan, giving you a measure of financial security that allows you to make prompt monthly repayments.

Types of 3-2-1 Buy-Down Mortgages

The entire cost of a mortgage buy-down is based on the upfront payment that reduces the monthly loan repayments, which is sometimes treated as the mortgage point. This additional amount, once calculated, can be placed in an escrow account that pays the difference every month.

Depending on the market conditions, you should conduct thorough research to ensure that your mortgage buy-down works out as a win-win situation. In some instances, you may find that the cost of a mortgage loan isn't reflective of the buying price, as it's been increased by the seller or builder to make up the cost difference.

State-funded or federal housing programs may not offer 3-2-1 incentives, for which conditions will vary depending on the mortgage lender. You also can't use this plan for refinancing or adjusting an existing mortgage.

3-2-1 Buy-Down Mortgage vs. Permanent Mortgage Buy-Downs

Although these two common types of mortgage buy-downs are related, the essential differences are in their methodology and timing. A 3-2-1 buy-down loan is a temporary arrangement that spans three years, while a permanent mortgage buy-down will involve buying down the interest rate for the entire loan duration.

At the inception of a permanent buy-down, discount loan points are offered on credit by the seller amounting to an interest reduction between 2% and 4%. Another buy-down option, the 2-1 plan, follows along the process of the 3-2-1 plan, except the arrangement lasts two years, with the first year seeing a reduced rate of 2%.

A 3-2-1 buy-down mortgage will afford you the chance to build up your finances to accommodate better repayments for the home loan. After paying an additional closing amount, you'll have qualified for a home that's priced higher than what you could normally afford while giving you lee time if you're expecting your income to increase.