The 2-1 buydown: how a temporary rate buydown works, who pays for it, and when it beats a price cut

How a 2-1 buydown works

Your loan has one interest rate for its whole life: the note rate. A 2-1 buydown does not change it. Instead, someone deposits a lump sum into a buydown account at closing. In year one, you make a payment calculated as if your rate were 2 percentage points lower, and the account pays the difference to the lender each month. In year two, your payment is calculated at 1 point lower. In year three the account is empty and you pay the full note-rate payment for the rest of the term.

So a temporary buydown is really a prepaid payment subsidy. The lender receives the full payment every month from day one. Fannie Mae requires the funds to be held in a custodial account and used only for the monthly payments as they come due. If you sell or refinance before the funds are used up, what happens to the remaining balance is governed by the buydown agreement; commonly it is credited toward the payoff.

A worked 2-1 buydown example

Here is the math on a $400,000 purchase with 20% down and a $320,000 loan, at a hypothetical note rate of 6.5%. The rate is a round number for illustration, not a Home State Bank quote, and the figures cover principal and interest only.

The cost of the buydown is simply the sum of the monthly subsidies: about $4,815 for year one plus about $2,468 for year two, or roughly $7,283. That is about 1.8% of the purchase price in this example. The buyer saves exactly that amount over 24 months, no more and no less. Nothing about the loan is cheaper after month 24.

Who pays: the seller paid buydown and contribution limits

Most temporary buydowns are paid by a seller or builder as a negotiated concession, and occasionally by a lender. When an interested party pays, the cost counts toward the interested party contribution limit for your loan type, together with any closing costs or points the seller is covering.

On a conventional loan, Fannie Mae's limits for a primary residence or second home are 3% of the lower of the price or appraised value when the loan-to-value ratio is above 90%, 6% from 75.01% to 90%, and 9% at 75% or below. Anything above the limit is treated as a sales concession and deducted from the price for underwriting. FHA caps interested party contributions at 6% of the sales price, and its list of covered items specifically includes temporary and permanent buydowns.

• Conventional, less than 10% down: 3% maximum contribution
• Conventional, 10% to just under 25% down: 6%
• Conventional, 25% or more down: 9%
• Conventional investment property: 2%, and Fannie Mae does not permit temporary buydowns on investment properties or cash-out refinances
• FHA: 6% of the sales price

You qualify at the note rate, not the reduced rate

This is the rule that surprises people. Fannie Mae requires the lender to qualify the borrower at the note rate, without regard to the bought-down rate. A 2-1 buydown therefore does not help you qualify for a bigger loan. If the full payment does not fit your debt-to-income ratio, the buydown does not fix that.

What it does is ease the first two years, which is when cash is tightest: you have just paid a down payment and closing costs, bought a lawnmower, and found out what the last owner did to the water heater. It also suits buyers who reasonably expect income to rise, such as a household returning to two incomes. It is a poor fit for anyone who is counting on a refinance to avoid the year-three payment. Rates may not cooperate, and the payment you qualified for is the one you should plan to make.

The 3-2-1 buydown and other temporary buydown structures

The same idea comes in other sizes. A 1-0 buydown reduces the payment by 1 point for one year. A 3-2-1 buydown steps through three years at 3, 2, and 1 points below the note rate. Fannie Mae's rules allow a buydown period of up to three years, a total reduction of up to 3 percentage points, and payment increases of no more than 1 point per year.

Bigger buydowns cost much more. On the same hypothetical $320,000 loan at 6.5%, a 3-2-1 structure would cost roughly $14,300, about double the 2-1, which collides with contribution limits quickly for buyers with small down payments.

Temporary buydown vs permanent points vs a price cut

If a seller is willing to part with about $7,300, there are several ways to take it. Each wins in a different situation, so look at them side by side with your own numbers.

A price cut of $7,300 at the example rate lowers the payment by only about $37 a month with 20% down, but it is permanent and it reduces the cash you need to close. The same money as permanent discount points might lower the rate for the life of the loan, which wins if you stay many years. The temporary buydown delivers the largest relief, soonest, and then ends.

Is a 2-1 buydown available at Home State Bank?

Buydown availability depends on the loan program and the market, and it changes. We are not going to tell you here that a specific buydown is on the menu today. Ask a loan officer what is available for your loan when you are writing the offer, ideally before your agent negotiates the concession, so the contract language matches what the loan can accept.

What we can say is how we look at the underlying goal. As a portfolio lender that approves and services loans in-house, we can sit down with a Lake in the Hills or Little Chute buyer and look at the same concession several ways: toward points, toward closing costs, or alongside a different loan structure such as an adjustable-rate mortgage. The right structure is the one that fits how long you will own the home.