Smarter Financing: Understanding 3-2-1 Interest Rate Buydown

Interest rates continue to be a top concern for prospective home buyers in Rhode Island, especially when faced with quotes as high as six, seven, or even eight percent. Many of my clients often wish they had entered the housing market when rates were more favorable, hovering around five or six percent. Fortunately, there’s a financial tool that can provide relief: the 3-2-1 buy-down loan program. In this blog post, I want to shed light on this program and show you how it can assist home buyers in managing their monthly payments and enhancing the affordability of homeownership. If you’re a home buyer you should research all of your options but this is an important tool for Seller’s to understand as well (more on that below).

Understanding the 3-2-1 Buy-Down Loan Program

The 3-2-1 buy-down loan program is a strategic approach to temporarily adjust fixed-rate mortgage products. It offers home buyers the opportunity to start their homeownership journey with the feeling of paying interest rates typically around five or four percent for the initial years of the loan. This program is designed to provide relief to buyers amidst a real estate market with soaring property prices.

Reducing Monthly Payments with the 3-2-1 Option

One of the primary objectives of the 3-2-1 buy-down loan program is to alleviate the burden of monthly mortgage payments for home buyers. When venturing into the housing market, the monthly payment is a critical consideration–I have a video about how to use the mortgage calculator and an entire page with a calculator on it for my clients to utilize. Given that most individuals don’t have the resources to purchase a home outright, they rely on mortgages. However, with mortgages, the duration isn’t indefinite, and the primary lever to reduce monthly payments is lowering the interest rate.

The 3-2-1 buy-down program empowers buyers to diminish their interest rates temporarily. This can be especially advantageous for individuals who’ve observed housing prices skyrocket due to escalating interest rates. For instance, if a buyer initially planned to commit to a $4,000 per month mortgage in 2022, the surge in interest rates might have limited their options. Instead of being able to afford a $949,000 house in 2022, they might find themselves limited to an $838,000 house in 2023 and a $600,000 house in 2024 due to both interest rate increases as well as price increases.

Introducing the 3-2-1 Buy-Down Loan Program

The 3-2-1 buy-down loan program offers a pragmatic solution to this predicament. It operates by prepaying a portion of the interest for the first three years of the loan through lender points. Let’s delve deeper into the mechanics of this loan product.

Visualizing the 3-2-1 Buy-Down Loan Program

To illustrate how the 3-2-1 buy-down loan program works, consider this example: Suppose a buyer is quoted a 7.25 percent interest rate for a $500,000 house, resulting in a monthly mortgage payment of $3,411. However, this payment might exceed the buyer’s initial budget. With the 3-2-1 buy-down program, the buyer can make their monthly payment appear as if they have a lower interest rate for the first three years. In this example, the payment would resemble a 4.25 percent interest rate for the first year, 5.25 percent for the second year, and 6.25 percent for the third year. After this initial period, the interest rate reverts to the fixed 7.25 percent.

It’s crucial to note that the 3-2-1 buy-down program doesn’t entail a variable interest rate. The rate remains fixed throughout the entire loan term. The program merely enables buyers to prepay a portion of the interest for the first three years, resulting in reduced monthly payments during that period.

Managing Monthly Payments with the 3-2-1 Buy-Down Loan Program

The 3-2-1 buy-down loan program is designed to empower buyers to manage their monthly payments effectively. For many prospective homeowners, the monthly payment is a pivotal factor. By leveraging this program, buyers can potentially free up more funds each month, rendering their monthly payments more manageable.

While it’s important to acknowledge that the 3-2-1 buy-down program comes with a cost—prepayment of interest—it can still be a valuable option for those seeking to enhance their monthly cash flow. By prepaying a portion of the interest, buyers can potentially secure a lower monthly payment, which can significantly impact their budget.

Who Pays the Points?

In the 3-2-1 buy down loan program, the buyer does not pay the points–in fact the buyer CANNOT. This means it needs to be negotiated as a seller paid credit. This is one of the primary challenges—it’s all good and find to know this is an option but are we in a position to request the seller to pay $10k, $15k, or $20k to cover the cost? This is where your real estate agent (hi, it’s me!) will work with you to craft your offer. It will depend upon the individual property and circumstances to determine whether or not a Buy Down is an opportunity we can take advantage of. This is an example of why it’s so important that you understand all of your options and that you work with a real estate agent (and a lender) that can help to guide you.

What Happens if I Sell or Refinance Within the First Three Years?

If a buyer sells or refinances within the first three years of the loan, they will be reimbursed for the prepaid interest at the closing. This means that any money paid towards the interest will be returned to the buyer when they sell or refinance the property.

The 3-2-1 buy down loan program offers a solution for home buyers who want to lower their monthly payments and manage their cash flow. By prepaying a portion of the interest for the first three years, buyers can make their monthly payments more affordable. While there is a cost associated with prepaying the interest, it can be a beneficial option for those who need to manage their monthly cash flow.

Financial expert Dave Ramsey suggests an alternative approach of putting down a larger down payment to save even more money in the long run. By putting down a larger down payment, buyers can potentially save thousands of dollars over the course of the loan. And sure–that’s a great idea but the fact is it’s not always possible for people to save twenty percent—and it might not make sense continuing to rent while you save for a larger down payment. As always, real estate investments are all about the numbers and there is a cost-analysis to waiting that buyers need to consider. 

A Smart Seller Strategy

For home sellers, understanding the 3-2-1 buy-down loan program can be a savvy strategy in our toolbelt. Instead of immediately resorting to price reductions to attract buyers, sellers can consider offering a credit to cover the prepaid points, effectively lowering the buyer’s interest rate. This can be a win-win scenario. Sellers can maintain their desired listing price, which is often crucial for maximizing returns, while simultaneously sweetening the deal for potential buyers by reducing their long-term interest expenses. In essence, it provides sellers with a valuable tool to differentiate their property and enhance the overall appeal of their listing, potentially leading to quicker sales and more favorable negotiations.

Overall, the 3-2-1 buy down loan program can be a helpful tool for home buyers who want to lower their monthly payments and manage their cash flow. It’s important to consider individual circumstances and financial goals when deciding if this program is the right option. Make sure you choose to work with a lender that will help you to evaluate the best loan option that works best for your financial needs and goals. I have vetted the best local lenders and am happy to share their contact info with you—send me a message!

Would you like to get a copy of my 3-2-1 and other Buy Down options Spreadsheet to see these numbers in action? Send me a message and I will share it with you!