Freddie Mac Guidelines: Temporary Subsidy Buydown Plans

What Is a Temporary Subsidy Buydown Plan

A temporary subsidy buydown plan lets you pay a lower interest rate for the first few years of your mortgage. Someone — usually the seller, builder, or lender — deposits money into an escrow account at closing. This money gets applied to your monthly payment each month, covering the difference between what you pay and what you would pay at the full interest rate.

Say you get a 30-year fixed loan at 7% interest, but the seller funds a 2-1 buydown. Your rate starts at 5% in year one, jumps to 6% in year two, then goes to the full 7% in year three. The seller deposits enough money at closing to cover those payment reductions for 24 months.

Fannie Mae recognizes two types of buydown plans. Limited buydowns reduce your rate by up to 2 percentage points and last up to 2 years. Extended buydowns can reduce your rate by up to 3 percentage points but cannot last more than 3 years.

How Qualification Works

Here's the catch that surprises many borrowers: you must qualify at the full note rate, not the reduced buydown rate. If your loan has a 7% note rate with a 2-1 buydown, the lender calculates your debt-to-income ratio using the 7% payment.

This rule exists because your payment will eventually reach the full note rate. Fannie Mae wants to ensure you can afford the loan when the buydown period ends. If you can barely qualify at the reduced rate, you might struggle when your payment increases.

For adjustable-rate mortgages with buydowns, qualification gets more complex. The lender must follow the standard ARM qualification rules in [[B3-3.1-04]], which typically means qualifying you at a rate higher than the initial note rate.

Required Documentation

Your loan file must contain a signed buydown agreement that spells out exactly how the arrangement works. This agreement must state that the buydown funds get applied automatically each month and that you remain responsible for the full payment if the buydown money runs out.

The lender must also document their calculations showing the total cost of the buydown plan and any contributions from interested parties. They need to show the annual percentage increase in your principal and interest payment during the buydown period.

The buydown agreement must prevent you from accessing the escrowed funds directly. You cannot assign, transfer, or withdraw money from the buydown account except as the agreement allows.

Loans That Cannot Use Buydowns

Several loan types cannot use temporary buydown plans. Investment property loans are completely ineligible — buydowns only work for primary residences and second homes.

Cash-out refinances cannot use buydown plans either. However, rate-and-term refinances can use buydowns as long as the buydown funding does not come from a lender credit generated by increasing your interest rate.

Certain ARM products also face restrictions. The 3/6-month ARM and 5/6-month ARM secured by 3-4 unit primary residences cannot use buydown plans.

Funding Requirements

The buydown account must be fully funded at closing before your loan can be delivered to Fannie Mae. This means whoever is paying for the buydown — whether it's the seller, builder, or lender — must deposit the entire amount upfront.

The lender calculates the exact funding amount based on the payment differential over the buydown period. For a $400,000 loan with a 2-1 buydown, they determine how much extra you would pay at the full rate versus the reduced rates, then require that full amount at closing.

If the funding comes from the seller or builder, it counts as an interested party contribution and must comply with Fannie Mae's contribution limits. These limits vary by loan-to-value ratio and loan program.

Note and Mortgage Document Rules

Your promissory note and mortgage documents cannot reference the buydown plan at all. The note must show the full interest rate and the payment amount calculated at that rate, not the temporary reduced payment.

This separation protects both you and the lender. If the buydown account runs out of money, you still owe the full payment shown in the note. The buydown agreement cannot change the fundamental terms of your mortgage.

The monthly payment amount on your loan application and closing documents will show the full note rate payment, even though you'll initially pay less due to the buydown.

What Happens During the Loan Term

Each month, your servicer automatically applies money from the buydown account to reduce your payment. You pay the reduced amount, and the escrowed funds cover the difference.

If you sell the home and the buyer assumes your loan, the buydown can continue under the original terms. If you pay off the loan early, any remaining buydown funds get distributed according to the buydown agreement — typically back to whoever funded the account.

In foreclosure situations, any remaining buydown funds must be applied to reduce the mortgage debt rather than returned to the funding party.

Common Complications

The biggest surprise for borrowers is qualifying at the full note rate when they expected to qualify at the reduced rate. This can derail loan applications where buyers counted on the lower payment to meet debt-to-income requirements.

Another issue arises with interested party contribution limits. If the seller funds the buydown and also pays other closing costs, the total might exceed Fannie Mae's contribution limits for your loan-to-value ratio.

Some borrowers assume they can access the buydown funds if they need cash later. The agreement specifically prohibits this — the money stays locked in the account for its intended purpose.

Timing can create problems too. If the buydown funding doesn't arrive by closing, the loan cannot be delivered to Fannie Mae until the account is fully funded.

References

For the official guidelines, see 4204.3: Temporary subsidy buydown plans in the Fannie Mae Selling Guide.