3-2-1 Buydown: Temporary Rate Reduction Mechanics for MLOs

The 3-2-1 buydown is a seller-paid or builder-paid concession that temporarily reduces the borrower's effective rate for the first three years of the loan. Year one sits 3 percentage points below the note rate, year two is 2 points below, and year three is 1 point below. From year four onward, the borrower pays the full note rate.

Borrowers Always Qualify at the Full Note Rate

Under QM lending rules, the qualifying payment is always based on the full contract note rate regardless of the buydown subsidy. A borrower who cannot qualify at the note rate is not made eligible by the buydown. The reduced first-year payment is a cash-flow benefit, not a qualifying benefit.

How the Buydown Escrow Account Works

• ✦Funds deposited at closing into a custodial escrow account, typically by the seller or builder
• ✦Each month the servicer draws the payment shortfall from escrow to cover the difference between the buydown payment and full P&I
• ✦If the loan pays off early, most lenders apply remaining escrow funds to principal reduction rather than refunding the seller
• ✦The funding cost runs roughly 1.5 to 2.2 percent of the loan amount depending on loan size and the rate environment

Seller Concession Limits Still Apply

The buydown cost counts against seller concession limits. On conventional loans, limits vary by LTV: 3% above 90% LTV, 6% at 75 to 90% LTV, and 9% below 75% LTV. FHA caps seller concessions at 6% of the lesser of appraised value or sales price. VA allows 4% in seller concessions plus reasonable discount points. USDA mirrors FHA at 6%.

Best Use Cases

New construction builders use 3-2-1 buydowns heavily in rate-sensitive markets because they can price the cost into the home without reducing the base price. For owner-occupant borrowers, the first-year savings can offset moving costs or carry them to a refinance if rates drop. Investors and DSCR borrowers rarely benefit since qualifying income calculations remain at the note rate.