The temporary buy-down program reduces the interest rate for only a short period of time, usually two years. The most common temporary buy-down is the 2-1 and 1-1 temporary buy-down programs. The 2-1 buy-down reduces the interest rate by two (2) percentage points during the first year of the loan and by one (1) percentage point during the second year of the loan; the loan returns to the note rate in the third year. By comparison, the 1-1 buy-down program reduces the interest rate by one (1) percentage point during the first two years of the loan; it returns to the note rate in the third year. The temporary buy-down program is advantageous for borrowers who wish to qualify for a larger loan amount, than their income normally could with standard loans. By lowering the interest rate—and consequently the monthly payments—during the first years of the loan, the prospective borrower can qualify for a higher loan amount. Many developers offer to subsidize such buy-downs to more quickly market their newly built homes. The temporary buy-down are normally applied only to conforming fixed-rate loans. However, some lenders allow this option on certain balloon and ARM programs as well. The main disadvantage of the temporary buy-down program is its higher note rate. This high note rate is offset by the low start rate. However, once the buy-down period is complete, the loan’s interest rate will be relatively higher (than standard loan programs) for the rest of its term. For example, if the current market rate for a 30-year fixed-rate loan is 8.000%, the note rate of the same program with a 2-1 buy-down would probably be 9.000%. During the first year, the start rate will be 7.000% (9.00% note rate less 2-point first-year reduction). In the second year, the interest rate will increase to 8.000% (9.00% note rate less 1-point second-year reduction).
In the third and subsequent years of the loan, the interest rate will return to the note rate of 9.000%. Fortunately, most buy-down programs do not have prepayment penalties; so the borrower can refinance to lower rate, if currently available.
Temporary Buy-down Requirements
The temporary buy-down programs are options that the lender may offer on select programs. The restrictions of those specific programs guide the equirements imposed upon the borrower. However, many 2-1 temporary buy-down programs will require that the prospective borrower demonstrate potential for increased income. This is usually accomplished with a standard verification form completed by the employer or documentation of steadily increasing income.
Temporary Buy-down Mechanism
Most temporary buy-downs establish an interest-subsidy escrow account for the period of the temporary buy-down. The funds in this escrow account are essentially prepayment of the interest during the first years of the loan. The funds for this interest-subsidy escrow account is normally provided by either the lender or the seller/developer. A seller or developer may provide such buy-down funds as an incentive or assistance for the buyer. The borrower may also elect to pay these funds, as applicable, from his or her own assets.