How do mortgage rate buydowns work?

Short answer

"Rate buydown" is a name for two different deals that are easy to confuse.

• A temporary buydown (the common versions are called 2-1 and 1-0) is money set aside at closing to reduce your principal-and-interest payment for the first year or two. The interest rate on your loan does not change. Fannie Mae's rules say the mortgage documents must show the full, permanent terms, and that the buydown "may not change the terms of the mortgage note."⁶ Under Fannie Mae's rules, the lender also has to qualify you at the full note rate, not the reduced one.⁶
• A permanent buydown means paying discount points at closing to get a lower interest rate for the life of that loan. One point costs 1% of the loan amount.¹ How much rate one point buys is not fixed. It depends on the lender, the loan, and the market.¹²

Who can pay depends on which kind it is and which loan program you're using. Discount points are usually paid by the buyer, but a seller or builder can pay them.² Fannie Mae allows temporary buydown funds from the buyer, the lender, the buyer's employer, the seller, or other interested parties.⁹ Seller and builder money is capped, and the cap depends on the program, occupancy, and down payment.⁷ Seller-paid money isn't automatically free, because sellers often price it in.⁵

Three things to keep in mind throughout:

1. The payments in this guide are principal and interest (P&I) only, not your full monthly payment.³
2. Whether a buydown is worth it depends on how long you keep this loan, not just the house.
3. No one can promise you a future refinance. Don't buy a temporary buydown on the assumption that rates will fall.

1. Two different trades

Temporary buydown: a payment subsidy, same note rate

With a temporary buydown, someone deposits a lump sum, which Fannie Mae calls a "subsidy," into a buydown account at closing. Part of it is released each month to cover part of your payment.⁹ Fannie Mae's loan-delivery guidance says plainly that "the actual note rate and monthly payment that the borrower is obligated to pay is never actually reduced."⁹

The names describe how far below the note rate your payment is calculated each year:

"Points" in this table means percentage points of interest rate, not discount points.

Your loan pays down the same way. The buydown money is applied to your payments "as they come due under the note,"⁶ so your balance pays down exactly as it would without a buydown. In the example below, the balance after one year and after two years is identical with or without the subsidy.

Fannie Mae allows temporary buydowns on fixed-rate loans and certain ARMs for principal residences and second homes, with a reduction of no more than 3 percentage points, increases of no more than 1 percentage point a year, and a buydown period no longer than 3 years.⁶ Investor properties and cash-out refinances are not eligible under Fannie's rules.⁶ Freddie Mac's public product page also lists investment-property loans as ineligible and says fixed-rate borrowers are qualified at the note rate.¹¹ That page says it isn't a substitute for Freddie's Seller/Servicer Guide, and this guide doesn't restate Freddie's exact limits. Ask your lender for the rules on your specific loan program.

Two consequences buyers often miss:

• It usually doesn't help you qualify. Under Fannie Mae's rules (and, per Freddie's product page, for Freddie fixed-rate loans), you're qualified at the full note rate.⁶¹¹ Plan on being able to afford the full payment from the start. Other loan programs have their own rules.
• If the buydown money runs out for any reason, you still owe the full payment. Fannie Mae says the borrower "is not relieved of the obligation" to make the note payments if the buydown funds aren't available.⁶

Permanent buydown: pay more now for a lower rate

Discount points work the other way. The CFPB's summary: "Points lower your interest rate, in exchange for paying more at closing."¹ Points listed on your Loan Estimate and Closing Disclosure "must be connected to a discounted interest rate."¹

What a point buys varies. The CFPB says a borrower with a $400,000 loan "might have to pay one discount point ($4,000) to reduce their interest rate by 0.25%, but another lender might equate one discount point, at the same cost, with a higher or lower interest rate reduction."² There is no standard conversion. Compare actual quotes.

2. Who can pay, and what limits apply

Who can pay depends on two things: which type of buydown it is, and which loan program you're using.

Interested-party money is capped (Fannie Mae). For a Fannie Mae loan, "interested parties" include the seller, builder or developer, the real estate agent or broker, and their affiliates.⁷ If a temporary or permanent buydown is paid by an interested party, or by a lender affiliated with one, the cost counts toward Fannie Mae's limit on interested-party contributions.⁷ A lender is not treated as an interested party unless it is the seller or is affiliated with the seller or another interested party.⁷ Buydown money you pay yourself isn't interested-party money.

Fannie Mae's caps are based on the lower of the sales price or appraised value, not the loan amount:⁷

The 2% row for investment property is Fannie Mae's general cap on financing concessions, including permanent discount points.⁷ It is not a temporary-buydown eligibility rule. Temporary buydown plans are ineligible on investment property, as this guide already states.⁶

The buydown counts toward the same cap as any other interested-party financing concessions in the deal, not a separate one. Fannie Mae also requires financing concessions not to exceed your actual closing costs. Any amount above that, or above the cap, is treated as a sales concession and comes off the price for LTV purposes.⁷

These are Fannie Mae limits only. They vary by occupancy and down payment, and they apply to 1–4 unit homes (see section 6). Freddie Mac, FHA, VA, and USDA loans have their own rules. This guide doesn't state those limits, so ask your lender which ones apply to your loan.

Seller-paid isn't the same as free. The CFPB says that when a seller pays closing costs, "that doesn't mean the closing costs are free," and that "a seller usually requires a higher purchase price if they are paying for the buyer's closing costs."⁵ A seller-funded buydown is part of the price negotiation. Compare it to what the same money would do as a price cut or a closing-cost credit.

3. A worked example (hypothetical)

These numbers are made up to show how the math works. They are not current rates, typical costs, or a lender offer.

At 6.50%, the monthly P&I payment is $2,022.62.

Payments are rounded to the cent, and each subsidy is the difference between two rounded payments. A real buydown agreement may round a little differently, so totals can be off by a few cents. A real total payment would also include property taxes, homeowners insurance, possibly mortgage insurance, and any HOA dues. None of those are in these tables.³

Temporary 2-1 buydown

Temporary 1-0 buydown

In both plans the loan balance pays down exactly as it would with no buydown: about $316,423 after 12 months and about $312,607 after 24 months. That's because the note rate and the scheduled payment don't change. The subsidy just covers part of each payment.

If you pay for it yourself, a temporary buydown mostly moves money around in time. You put $7,283.16 in at closing and get the same amount back as lower payments over two years. That can help if you expect more income soon or need breathing room early on. It doesn't lower what the loan costs you overall, and it adds to the cash you need at closing.

If the seller or builder pays, you pay less in the first year or two than you would on the same loan without it. Whether that's the best use of the money depends on what you gave up for it, such as a price cut or a closing-cost credit.

Permanent: 1 discount point

The 0.25-point rate cut is an assumption for this example only. The CFPB's own example uses the same magnitude and then warns that another lender might give more or less for the same point.²

Same money, different product

The $7,283.16 that funds the 2-1 plan above is about 2.28 points on this $320,000 loan. We're not going to guess what rate 2.28 points would buy, because there's no universal conversion.² If a seller is offering that much, ask your lender to quote both options: the 2-1 buydown and the same dollars applied to discount points. Then compare them over the time you actually expect to keep the loan.

4. What simple break-even leaves out

The CFPB describes break-even as something that "can be roughly estimated by dividing the cost of the discount points by the borrower's monthly savings."² It's a useful first check, but it's rough. It leaves out:

• What else the cash could do. Money spent on points isn't available for reserves, repairs, or a bigger down payment, and it isn't earning anything.
• Taxes. Not modeled here. Ask a tax professional.
• The rest of your payment. Taxes, insurance, mortgage insurance, and HOA dues aren't included.³
• Leaving early. If you sell or refinance before the break-even month, you probably won't recover what you paid for the points. The CFPB notes that points are "less useful for cash-strapped borrowers and those who expect to refinance or move in the near future."²

Break-even doesn't really apply to a temporary buydown you pay for yourself, because the rate never changes. You're paying now to pay less later, dollar for dollar.

5. How long you'll keep the loan, refinancing, and unused funds

The CFPB suggests asking a loan officer to show options with and without points and to "calculate the total costs over a few different possible timeframes," using "the shortest amount of time, the longest amount of time, and the most likely amount of time you can see yourself keeping the loan."¹ Points "can be a good choice if you plan to keep your loan for a long time."¹

The question is how long you'll keep this loan, not how long you'll own the home. A refinance ends the loan just as a sale does.

Don't count on a refinance. A temporary buydown is sometimes pitched as "you'll refinance before the payment goes up." Rates, your income, your credit, and your home's value can all change. Under Fannie Mae's rules you're qualified at the full rate, so plan as if you'll make the full payment.

Unused temporary buydown funds. If a Fannie Mae loan is paid off before the subsidy is used up, the remaining funds "should be credited to the total amount required to pay off the mortgage, or they may be returned to either the borrower or the lender as specified in the buydown agreement."⁶ So they don't necessarily go back to you. Read the buydown agreement.

6. These rules are for 1–4 unit homes, not apartment buildings

Fannie Mae's Single-Family Selling Guide, the source of the temporary-buydown and contribution-limit rules above, covers loans on residential properties of one to four units.⁸ Fannie Mae's separate Multifamily Guide covers properties with at least five units.¹⁰

If you're buying a 5+ unit apartment building or other commercial property, none of the rules above apply. Financing terms for those loans come from a different set of rules and lender negotiations. Even for 1–4 unit homes, eligibility varies by occupancy, number of units, and loan program. For example, Freddie Mac's product page says buydowns aren't allowed on Home Possible loans for 3- to 4-unit properties.¹¹

Questions to ask your lender

• What loan program is this (conventional/Fannie Mae, Freddie Mac, FHA, VA, USDA, or other), and which buydown rules and contribution limits apply?
• Am I qualified at the note rate or the reduced rate?
• Please quote the same loan three ways: no points, with points, and with a 2-1 or 1-0 buydown. What's the rate and the upfront cost for each?
• If the seller is contributing, how much of it can go to a buydown, points, or closing costs on this loan?
• What happens to unused buydown funds if I sell or refinance early? Where does the buydown agreement say that?
• What's my full estimated monthly payment, including taxes, insurance, and any mortgage insurance, after the buydown ends?

Check your Loan Estimate for the points and credits, and compare it to your Closing Disclosure before closing.

What this guide can't tell you

• Your lender's actual rates, points pricing, or buydown quotes
• Whether you qualify for a loan, or for a buydown on a particular loan
• FHA, VA, USDA, or other program rules and contribution limits (not covered here)
• Freddie Mac's exact buydown and concession limits (program-specific; this guide relies only on Freddie's public product page, which says it isn't a substitute for the Guide)
• State-, lender-, or contract-specific terms
• Whether unused buydown funds will come back to you
• Whether you'll be able to refinance, or when
• Tax treatment of points

FAQ

Related on Caza

• How much cash do you need to close on a Zillow listing? Points and a self-funded buydown both add to cash to close, and seller credits share the same limits.
• Rate drop vs. price cut calculator. This compares a lower rate with a lower price on P&I. It doesn't model buydown funding or the cost of points.
• Rate buydown calculator. Compares a baseline loan with a 2-1, a 1-0, and discount points using a rate you type in. Hypothetical principal and interest only.

You don't need Caza to do any of this. Your Loan Estimate and a few lender quotes are enough. Caza is a Chrome extension, if you want listing numbers in one place while you shop.

Caza is not affiliated with or endorsed by the CFPB, Fannie Mae, or Freddie Mac. This guide is general information, not financial, legal, tax, or lending advice.