A buydown mortgage lowers your interest rate through money paid upfront at closing, either for the first few years of the loan or for its entire life. A temporary buydown uses a lump sum deposited into an escrow account to subsidize your monthly payments for one to three years, while a permanent buydown uses discount points to reduce the rate on your promissory note for good. Both cut what you pay each month; the mechanics, the cost, and who benefits are very different.
How a Temporary Buydown Works
A temporary buydown is built around a dedicated escrow account funded at closing. That lump sum covers the gap between what you actually pay each month and what the lender would collect at the full note rate. Each month during the buydown period, a portion of the escrow releases to the lender. You write a smaller check. The lender still receives the full payment.
Your loan’s actual interest rate never changes. The note rate is fixed from day one. What changes is the split between your pocket and the escrow account. When the escrow runs dry at the end of the buydown period, you pay the full note-rate payment for the remainder of the loan.
The 2-1 and 3-2-1 Structures
The most common temporary buydown is the 2-1. Your effective rate is 2 percentage points below the note rate in year one and 1 point below it in year two. From year three on, you pay the full note rate. On a 7% loan, that means payments calculated at 5%, then 6%, then 7%.1Investopedia. What Is a 2-1 Buydown Loan and How Do They Work
A 3-2-1 buydown extends the discount by a year and deepens it in year one: 3 points off, then 2, then 1, then full rate in year four. The first-year savings are larger, but so is the upfront deposit, because the escrow now has to subsidize three years of payments.2Federal Housing Finance Agency Office of Inspector General. Temporary Interest Rate Buydowns Dashboard
Fannie Mae caps temporary buydowns at a 3 percentage point reduction, with annual step-ups of no more than 1 point. The 3-2-1 is the most aggressive structure allowed under conventional lending.3Fannie Mae. Temporary Interest Rate Buydowns – Fannie Mae Selling Guide
What the Deposit Actually Costs
The dollar cost of a temporary buydown equals the total subsidized interest across the buydown period. Take a $400,000 loan at 7% with a 2-1 buydown. In year one, payments are calculated at 5%, saving roughly $514 a month, or about $6,167 over twelve months. In year two, payments run at 6%, saving roughly $263 a month, or about $3,156. The escrow deposit at closing comes to about $9,323.
That money doesn’t cut your loan balance or build equity. It just lowers your out-of-pocket payment for two years. When the escrow empties, the payment jumps to the full amount.
How a Permanent Buydown Works
A permanent buydown skips the escrow entirely. You pay discount points at closing to lower the note rate itself for the life of the loan. One point costs 1% of the loan amount and typically reduces the rate by somewhere between 0.125% and 0.25%, depending on the lender. On a $400,000 loan, one point runs $4,000.
Because the lower rate applies to every payment across 15 or 30 years, the total savings can far exceed what a temporary buydown produces. The trade-off is that the cash comes out of your pocket, and the rate on the promissory note actually changes, which is not the case with a temporary buydown.
The Break-Even on Discount Points
Before paying for points, figure out how long it takes to recover the upfront cost. Divide the cost of the points by the monthly savings. If one point costs $4,000 and cuts your payment by $60, you break even at about 67 months, roughly five and a half years.
That number is the dividing line. Sell or refinance before it, and you paid more than you saved. Stay past it, and every payment after that is net savings. Borrowers planning to stay seven years or more usually come out ahead on points. Borrowers who might move within a few years typically don’t.
Who Pays for the Buydown
The subsidy can come from three sources, and the source shapes the deal:
- Home builders and sellers fund most temporary buydowns. A builder sitting on unsold inventory may fund a 2-1 as a concession rather than cut the list price, because a headline price reduction can drag down comparable sales in the neighborhood.
- Lenders occasionally fund part of a buydown to make their products more competitive. This is less common.
- Borrowers can fund their own buydown, though this is the rarest arrangement. It makes sense only if you have extra cash at closing and would rather have lower early payments than a larger down payment.
When a seller or builder pays, the money counts as an interested party contribution and runs into regulatory limits.
Concession Limits by Loan Type
Every loan program caps what sellers and other interested parties can contribute to a buyer’s costs, including buydowns. Blow through the cap and the deal has to be restructured.
Conventional Loans
Fannie Mae ties the maximum contribution to your loan-to-value ratio:
- LTV above 90%: up to 3% of the sale price or appraised value, whichever is lower.
- LTV between 75.01% and 90%: up to 6%.
- LTV of 75% or less: up to 9%.
- Investment properties: 2% regardless of LTV.
Any contribution over the cap must be subtracted from the sale price, which forces a fresh LTV calculation.4Fannie Mae. Interested Party Contributions (IPCs) – Fannie Mae Selling Guide
FHA Loans
FHA allows interested party contributions of up to 6% of the sale price, and that 6% has to cover everything: origination fees, closing costs, prepaid items, discount points, and any temporary or permanent buydown.5U.S. Department of Housing and Urban Development. What Costs Can a Seller or Other Interested Party Pay on Behalf of the Borrower
VA Loans
The VA splits closing costs from concessions. Temporary buydowns and discount points count as negotiable closing costs, and the VA does not cap seller contributions toward those costs. Seller concessions, a separate category covering things like paying off the buyer’s debts or prepaying hazard insurance, are capped at 4% of the home’s reasonable value.6Department of Veterans Affairs. VA Funding Fee And Loan Closing Costs
A seller-funded 2-1 buydown on a VA loan does not eat into the 4% concession cap, which gives VA buyers more room for buydown arrangements than they often realize.
Tax Treatment
The IRS treats discount points as prepaid interest. If you itemize on Schedule A, you can generally deduct the full amount of points in the year you pay them, provided the loan is for buying or building your principal residence. The points must be calculated as a percentage of the loan amount, must be clearly shown on your settlement statement, and cannot exceed what is customary in your area.7Internal Revenue Service. Topic No. 504 – Home Mortgage Points
One quirk: if the seller pays points on your behalf, the IRS still treats them as paid by you from unborrowed funds, so you get the deduction. But you also have to reduce your cost basis in the home by the amount of seller-paid points, which can slightly raise your capital gains liability at sale. Most homeowners are shielded by the primary residence exclusion.7Internal Revenue Service. Topic No. 504 – Home Mortgage Points
Temporary buydown subsidies produce no deduction for the borrower. The money sits in escrow and is released to the lender over time rather than paid as interest at closing.
Risks and Drawbacks
Payment Shock in Year Three
A 2-1 buydown on a 7% loan can raise your payment by several hundred dollars a month when the subsidy ends. The FHFA Office of Inspector General has flagged this directly, noting that borrowers “may be unable to adjust spending behavior for the full payment after the buydown period.”2Federal Housing Finance Agency Office of Inspector General. Temporary Interest Rate Buydowns Dashboard
Planning around a temporary buydown works best when your income is actually expected to grow. Counting on a refinance into lower rates before the subsidy expires is a bet on the rate environment, and rates may not cooperate.
Qualification Uses the Full Rate
Lenders must qualify you at the note rate, not the reduced payment. Fannie Mae’s selling guide is explicit that “the lender must qualify the borrower based on the note rate without consideration of the bought-down rate.”3Fannie Mae. Temporary Interest Rate Buydowns – Fannie Mae Selling Guide A buydown will not stretch your borrowing power. It makes the early payments easier; it does not let you afford a bigger loan.
Unused Escrow Funds
If you pay off the loan or sell the home before the buydown period ends, the leftover escrow money does not disappear. Under Fannie Mae rules, unused funds are either credited toward the payoff or returned to the borrower or lender according to the buydown agreement.3Fannie Mae. Temporary Interest Rate Buydowns – Fannie Mae Selling Guide
Choosing Between the Two
The decision comes down to how long you plan to keep the loan and who is paying. A seller-funded 2-1 costs you nothing out of pocket and delivers real savings for two years. If a builder is offering one as a concession on new construction, there is little reason to turn it down.
Paying for discount points with your own cash is a different calculation. You need to stay past break-even to come out ahead, which usually means holding the loan five to seven years or more. If there is a realistic chance you will move or refinance sooner, the money is better used on a larger down payment or reserves.
The two tools can also be stacked. A borrower can buy one or two discount points to permanently lower the rate while the seller funds a 2-1 buydown on top. The result is lower payments in the early years and a permanently reduced rate afterward. Just confirm that the combined seller contribution fits inside the concession cap for your loan type.