Understanding 3-2-1 Buydowns for VA Loans and the 4% Seller Concession Rule

As a mortgage loan officer, it’s crucial to understand the various loan options and concessions available to veterans. One of the popular options is the 3-2-1 buydown, a mortgage financing technique that can help make homeownership more affordable for borrowers. However, when working with VA loans, it’s important to navigate the specifics of the 4% seller concession rule. Let's delve into the details of 3-2-1 buydowns for VA loans and how they interact with the 4% seller concession limit.

#### What is a 3-2-1 Buydown?

A 3-2-1 buydown is a type of temporary interest rate reduction offered to borrowers. The interest rate is reduced by 3% in the first year, 2% in the second year, and 1% in the third year, before returning to the original rate for the remainder of the loan term. This structure helps borrowers ease into their mortgage payments by starting with lower payments that gradually increase.

For example, if the original note rate is 5.625%, the rate would be:

2.625% in the first year

3.625% in the second year

4.625% in the third year

5.625% for the remaining term

#### Understanding VA Loan Seller Concessions

The Department of Veterans Affairs allows sellers to contribute up to 4% of the loan amount toward the buyer’s closing costs and other expenses, known as seller concessions. These concessions can cover various costs such as:

Prepaid taxes and insurance

Discount points to reduce the interest rate

The VA funding fee

Other closing costs

#### 3-2-1 Buydowns and the 4% Seller Concession Rule

A key consideration with VA loans is that the cost of the 3-2-1 buydown must fit within the 4% seller concession limit. The challenge arises because the buydown cost is typically high, especially when the original note rate is considerably higher than the rate after the buydown.

#### Cost Analysis of a 3-2-1 Buydown

To understand why a 3-2-1 buydown might not fit within the 4% seller concession rule, let’s look at a hypothetical scenario where the loan amount is $300,000:

**Original Note Rate**: 5.625%**Buydown Rates**:Year 1: 2.625%

Year 2: 3.625%

Year 3: 4.625%

The cost of the buydown is the difference between the monthly payments at the original note rate and the reduced rates, multiplied by the number of payments at each reduced rate.

#### Monthly Payment Calculations:

**Original Note Rate (5.625%)**: $1,726.71**Year 1 (2.625%)**: $1,204.22**Year 2 (3.625%)**: $1,368.18**Year 3 (4.625%)**: $1,540.57

#### Total Savings and Buydown Cost:

**Year 1**: ($1,726.71 - $1,204.22) * 12 = $6,277.88**Year 2**: ($1,726.71 - $1,368.18) * 12 = $4,304.04**Year 3**: ($1,726.71 - $1,540.57) * 12 = $2,232.96**Total Buydown Cost**: $6,277.88 + $4,304.04 + $2,232.96 = $12,814.88

In this scenario, the total buydown cost of $12,814.88 represents about 4.27% of the loan amount, exceeding the 4% seller concession limit allowed by the VA.

#### Meeting the 4% Concession Rule

To comply with the VA’s 4% rule, the note rate needs to be adjusted so that the buydown cost falls within the limit. For the cost to be within 4% ($12,000 for a $300,000 loan), the original note rate would need to be around 4.625%. Here’s why:

#### Adjusted Scenario:

**Original Note Rate**: 4.625%**Buydown Rates**:Year 1: 1.625%

Year 2: 2.625%

Year 3: 3.625%

#### Monthly Payment Calculations:

**Original Note Rate (4.625%)**: $1,538.23**Year 1 (1.625%)**: $1,028.28**Year 2 (2.625%)**: $1,211.62**Year 3 (3.625%)**: $1,402.02

#### Total Savings and Buydown Cost:

**Year 1**: ($1,538.23 - $1,028.28) * 12 = $6,120.60**Year 2**: ($1,538.23 - $1,211.62) * 12 = $3,922.32**Year 3**: ($1,538.23 - $1,402.02) * 12 = $1,634.52**Total Buydown Cost**: $6,120.60 + $3,922.32 + $1,634.52 = $11,677.44

At an original note rate of 4.625%, the total buydown cost is approximately 3.89% of the loan amount, fitting within the 4% seller concession limit.

### Conclusion

Understanding the interaction between 3-2-1 buydowns and the 4% seller concession rule is essential when working with VA loans. The key takeaway is that while 3-2-1 buydowns can make mortgage payments more manageable for borrowers, their cost must align with the VA’s 4% seller concession limit. By carefully evaluating the note rate and the buydown structure, you can ensure that your veteran clients benefit from both lower initial payments and compliance with VA regulations.

By staying informed about these nuances, you can better serve your clients and help them navigate the complexities of VA loans with confidence and ease.

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