The higher interest rate environment has given rise to a renewed interest in the use of temporary buydowns to help borrowers lower their initial monthly mortgage payments.  A temporary buydown allows a lender, seller, builder or other third party to deposit funds which will subsidize the borrower’s mortgage payments for a predetermined period of time, thereby reducing the borrower’s monthly payments during that agreed period.  Buydown funds can also be provided by borrowers themselves.

Temporary buydowns can be particularly attractive for first time homebuyers who will be making mortgage payments for the first time as well as borrowers who expect to have higher incomes in the future or who want to set aside money for other expenses while their monthly mortgage payments are lower.

Documenting the Buydown Terms

Typically, the terms of the buydown are not reflected in the note the borrower will execute as part of the mortgage transaction. Instead, due to Fannie Mae and standard investor requirements, the terms are set forth in a separate Buydown Agreement between the borrower and the party providing the buydown funds. Fannie Mae requires the note to reflect only the permanent payment terms rather than the terms of the buydown plan and requires the Buydown Agreement to provide that the borrower is not relieved of the obligation to make the full mortgage payments required by the terms of the note if, for any reason, the buydown funds are unavailable. 

If the lender funds the buydown, the Buydown Agreement must require that the funds in the buydown account be transferred to the new servicer if the mortgage servicing is subsequently transferred. 

It is important for borrowers to understand, particularly if they are contributing the buydown funds, that buydown funds are not refundable.  However, if the mortgage is paid off before all the funds have been applied, the agreement may include an option for the buydown funds to be returned to the borrowers or to the lender, if the lender funded the buydown.

Disclosing the Buydown – What are the Requirements

Whether the Loan Estimate and Closing Disclosure is required to reflect the terms of the buydown when disclosing information impacted by the buydown varies based on who is contributing the buydown funds and whether the buydown terms are included in the note.  The commentary in Reg. Z [12 CFR 1026.17(c)(1)] indicates that the Loan Estimate and Closing Disclosure must include the terms of the buydown agreement when either:

•   The borrower is contributing the buydown funds, regardless of whether the terms of the buydown are reflected in the credit contract (the note); or

•   A third party is contributing the buydown funds and the terms of the buydown are reflected in the credit contract.  As indicated above, Fannie Mae and most investors prohibit the note from including the terms of the buydown in the note so these types of buydowns are less common.

The commentary provides that the terms of the buydown must not reflect the terms of the buydown if a third party contributes the buydown funds and the credit contract does not reflect the terms of the buydown. 

Special Considerations When Determining Loan Qualification

Lenders must use the note rate, rather than the bought-down rate, when determining whether the borrower qualifies for the loan as the borrower is still ultimately responsible for the full payment amounts even during the initial buydown period.  In addition, if buydown funds are contributed by interested parties to the transaction, Fannie Mae’s interested-party contribution limits will apply and must be taken into account.

Due to the complicated and unique nature of buydowns, proper and complete documentation of all aspects of the transaction is essential.  The use of a document provider that possesses the requisite subject matter expertise and necessary loan documents should be a priority.

The Propel™ document platform has the capability to incorporate a temporary buydown into loan packages for all states.  If you have any questions regarding buydowns or any of Propel’s other capabilities, please contact Franci Webster at fwebster@asurity.com. 

By Diane Jenkins, CMB
Director, National Mortgage Regulatory Compliance, Propel;
Partner, Sandler Law Group