What Makes Low Down Payment Loans Possible?
Simply put, mortgage insurance protects the mortgage company against financial loss if a homeowner stops making mortgage payments. Mortgage companies usually require insurance on low down payment loans for protection in the event that the homeowner fails to make his or her payments. When a homeowner fails to make the mortgage payments, a default occurs and the home goes into foreclosure. Both the homeowner and the mortgage insurer lose in a foreclosure. The homeowner loses the house and all of the money put into it. The mortgage insurer will then have to pay the mortgage company’s claim on the defaulted loan.
For this reason, it is crucial that the family buying the home can really afford it, not only at the time it is purchased, but throughout the time period of the loan.
Although the cost of the mortgage insurance is paid by the home buyer, or borrower, the mortgage insurer works directly with the mortgage company. Mortgage insurance is available to commercial banks, savings & loans and mortgage bankers, all of whom offer mortgage loans to home buyers.
Remember that mortgage insurance is not the same as credit life insurance, also called mortgage life insurance. This type of policy repays an outstanding mortgage balance upon the death of the person who took out the insurance policy.
The Secondary Market
The mortgage company’s decision to use mortgage insurance is driven by the requirements of investors in the mortgage market. Because of the losses that could occur, major investors require mortgage insurance on all loans made with low down payments.
The three primary investors in home loans are Federal National Mortgage Association (Fannie Mae), Federal Home Loan Mortgage Corporation (Freddie Mac) and Government National Mortgage Association (Ginnie Mae). By purchasing and selling residential mortgages, Fannie Mae and Freddie Mac help keep money available for homes across the country.
Unlike Fannie Mae and Freddie Mac, Ginnie Mae does not actually buy mortgages. It adds the guarantee of the full faith and credit of the U.S. Government to mortgage securities issued by mortgage companies.
The Two Choices: Government Insurance and Private Insurance
Now that we have explained how mortgage insurance works and why it is necessary, let’s look at the basic kinds of mortgage insurance. Low down payment mortgages can be insured in two ways — through the government or through the private sector. Mortgages backed by the government are insured by the Federal Housing Administration (FHA), the Department of Veterans Affairs (VA) or the Farmers Home Administration (FMHA).
Although anyone can apply for FHA insurance, the other two government mortgage guarantee programs are much more targeted. The VA program is limited to qualified, eligible veterans and reservists. This program is very specialized, so contact your mortgage professional for the details. The FMHA insures loans for the construction and purchase of homes in rural communities.
Obtaining conventional financing is the alternative to obtaining a home loan backed by the government. Conventional mortgages are all home loans not guaranteed by the government, including those guaranteed by private mortgage insurers.
Although government and private insurance are based on the same concept of allowing families to get into homes with less cash down, there are many differences between the two. Often, your mortgage professional will play an important role in suggesting and deciding which insurance is selected.
Home buyers must make a down payment of at least 5% of a home’s value to be considered for private mortgage insurance. However, under some special programs, the down payment requirement allows the buyer to use a gift or grant to cover 2% of the 5% down payment required by private mortgage insurers. The gift or grant may come from a friend, relative, community group or other organization.
Private mortgage insurance is available on a wide variety of home loans and there is no pre-set limit on the loan amount. Although differences such as these may affect whether the mortgage company prefers to work with government or conventional mortgages, your mortgage professional will discuss which one would be better for your situation.
With the wide variety of loans available, home buyers have the freedom to choose the type of loan that best suits their needs. Early on in the home buying process, it is a good idea to meet with several companies to compare the types of mortgages they offer and shop for the best price and terms. Best of all, working with a mortgage insurer can be very easy, whether your loan is insured by the FHA or a private mortgage insurance company, because your mortgage professional handles all of the arrangements.
By making lending money to home buyers safer, mortgage insurance helps more families get into homes of their own.
Down Payment Loans and Gifts
Loans and gifts can help with your down payment but you can not use this strategy for all loan programs. The most popular program for this tactic is the Federal Housing Administration or FHA. FHA allows 100% gift funds for your down payment. The gift can be from any relative or can be collected through new innovative programs, like the Bridal Registry where couples receive money into an account that can be used for the down payment.
Another popular tactic, which can be used in a wider range of programs, is to borrow from your 401K program. If you have a 401K program with your employer, you may be able to withdraw without a penalty for your down payment and pay it back over a specified period. There are some drawbacks, the payment will be used in qualifying and your 401K account will not continue to grow as fast. For this reason this is usually not suggested. You should seek the advice of your accountant and/or your financial advisor.
Down Payment – Grant That Is Never Repaid By The Homebuyer!
There are national non-profit organizations dedicated to assisting homebuyers with their down payment and closing costs.
Buyers can receive a free gift under these programs. Gift amounts vary with each program but are generally available in amounts of 3% with some programs, all the way up to $22,500 with others. Buyers never have to repay these gifts.
It’s easy to receive a free gift from these programs, however qualification guidelines do vary with each program. Each program requires that buyers must qualify for any eligible loan program with their lender (there are many programs that qualify).
While this is the ONLY qualifying requirement of some programs, others have requirements such as requiring that the buyer complete a Home Ownership Counseling Course or provide 1% of their own funds into the transaction. In addition some programs have income/asset restrictions, recapture clauses, reserves required, or geographic boundaries. Each program can provide you with their specific requirements and/or limitations
These programs generally participate with FHA, Conforming, and Non-Conforming loan products. Most of these programs do not underwrite the loan or add any cost in the form of points, fees, etc., they simply provide the gift for the down payment and/or closing costs.
These down payment assistance programs can be used for Single Family (1-4 unit) homes, Manufactured/Modular Homes, Condominiums, Townhouses, Existing or New Construction, Rehab and Non-Conforming.
Qualifying for a Low Down Payment Loan
To be considered for a low down payment loan, you generally need to have:
- Sufficient income to support the monthly mortgage payment
- Enough cash to cover the down payment
- Sufficient cash to cover normal closing costs and related expenses (explained below)
- A good credit background that indicates your payment history or “willingness to pay”
- Sufficient appraisal value, which shows the house is at least equal to the purchase price
- In some instances, a cash reserve equivalent to two monthly mortgage payments
Closing costs, or settlement costs, are paid when the home buyer and the seller meet to exchange the necessary papers for the house to be legally transferred. On average, closing costs run approximately 2% to 3% of the house price. This percentage may vary, depending on where you live.
Closing costs include the loan origination fee (if not already paid), points, prepaid homeowner’s insurance, appraisal fee, lawyer’s fee, recording fee, title search and insurance, tax adjustments, agent commissions, mortgage insurance (if you are putting less than 20% down) and other expenses. Your mortgage professional will give you a more exact estimate of your closing costs.
Points are finance charges that are calculated at closing. Each point equals 1% of the loan amount. For example, 2 points on a $100,000 loan equals $2,000. Companies may charge 1, 2 or 3 points in up-front costs in addition to the down payment. The more points you pay, the lower your interest rate will be. In some cases, you may be able to finance the points.
So How Much of a Mortgage Can You Afford?
There are two basic formulas commonly used to determine how much of a mortgage you can reasonably afford. These formulas are called qualifying ratios because they estimate the amount of money you should spend on mortgage payments in relation to your income and other expenses.
It is important to remember that the following ratios may vary and each application is handled on an individual basis, so the guidelines are just that — guidelines. There are many affordability programs, both government and conventional, that have more lenient requirements for low- and moderate-income families.
Many of these programs involve financial counseling for low- and moderate-income people interested in buying a home and in return, offer more lenient requirements.
Generally speaking, to qualify for conventional loans, housing expenses should not exceed 26% to 28% of your gross monthly income. For FHA loans, the ratio is 29% of gross monthly income. Monthly housing costs include the mortgage principal, interest, taxes and insurance, often abbreviated PITI. For example, if your annual income is $30,000, your gross monthly income is $2,500, times 28% = $700. So you would probably qualify for a conventional home loan that requires monthly payments of $700.
Any expenses that extend 11 months or more into the future are termed long-term debt, such as a car loan. Total monthly costs, including PITI and all other long-term debt, should equal no greater than 33% to 36% of your gross monthly income for conventional loans. Using the same example, $2,500 x 36% = $900. So the total of your monthly housing expenses plus any long-term debts each month cannot exceed $900. For FHA the ratio is 41%.
Maximum allowable monthly housing expense
26% – 28% of gross monthly income – Conventional
29% of gross monthly income – FHA
Maximum allowable monthly housing expense and long-term debt
33% – 36% of gross monthly income – Conventional
41% of gross monthly income – FHA
One way to determine how much to spend for housing is to compare your monthly income with monthly long-term obligations and expenses. Use the worksheet, “Evaluating Your Financial Resources,” to determine how much money you can spend on housing. Be sure to only include income you can definitely count on.
When budgeting to buy a home, it is important to allow enough money for additional expenses such as maintenance and insurance costs. If you are purchasing an existing home, gather information such as utility cost averages and maintenance costs from previous owners or tenants to help you better prepare for homeownership.
Homeowner’s insurance or property insurance is another cost you will have to consider. The lending institution holding the mortgage will require insurance in an amount sufficient to cover the loan. However, to protect the full value of your investment, you might want to consider purchasing insurance that provides the full replacement cost if the home is destroyed. Some insurance only provides a fixed dollar amount which may be insufficient to rebuild a badly damaged house.
Down Payment Assistance
The best-kept secret behind the sustained strength of the residential real estate market is the creation of a new pool of buyers who can afford their mortgage payments but lack the cash for a down payment. In the past these potential buyers had little hope of owning a home. Today, thousands of these individuals are becoming homeowners.
According to HUD the number one barrier to homeownership in the U.S. is the lack of down payment money. There is an increased need for organizations that can provide assistance through the use of private capital.
Through the use of private capital, the non-profit down-payment industry now makes possible over 17,000 home purchases each month for low to moderate income buyers. Today these Down payment Assistance Programs (which are not just for 1st time homebuyers) are helping many people live the dream of home ownership.
These organizations are supported through contributions made by home sellers. The donations help to replenish the pool of funds that are used for future buyers. Additionally the non-profits charge a small service fee, the proceeds of which allow them to stay operational.
Buyers are provided with gifts from the non-profits, which can be used towards their down payment and/or closing costs. These are true gifts that do not need to be repaid. The grants range from 2%-10% of the purchase price of the home. Home sellers typically agree to participate because they believe that they are receiving a fair offer for their home while at the same time they are benefiting from making a donation to a non-profit organization.
10 First time home buyer programs:
- FHA loan
- USDA loan
- VA loan
- Good Neighbor Next Door
- Fannie Mae or Freddie Mac
- Fannie Mae’s Home Path Ready Buyer Program
- Energy-efficient mortgage (EEM)
- FHA Section 203(k) and grants
- Native American Direct Lo
- State and Local first-time homebuyer
Benefits to Home Buyers
- Get into a home
- Begin building equity
- Start taking advantage of tax benefits
- May not have to deplete their entire savings
Benefits to Home Sellers
- Expose their home to a larger pool of buyers
- Typically will receive full price offers
- Sell their home faster
- Added benefit of making a donation to a non-profit
The organizations differ slightly with some providing additional benefits for the homebuyer. For instance the Home Down payment Gift Foundation has a program called “Home Mortgage Protection Plus”. This Program covers gift recipients who are enrolled in the Platinum Program against involuntary loss of employment. Should the gift recipient(s) lose their job during their first year of home ownership, the Foundation will provide for up to six months of mortgage payments (maximum of $1800.00 per month in P.I.T.I.) on their behalf.
The non-profits strongly encourage Home Ownership Counseling prior to the home purchase and some provide post-purchase counseling to its gift recipients.
The Gift Programs generally participate with FHA, Conforming, and Non-Conforming Loan Products. The down payment assistance program can be used for Single Family (1-4 unit) homes, Manufactured/Modular Homes, Condominiums, Townhouses, Existing or New Construction, Rehab and Non-Conforming.
While they do not provide any lending services, they can make available local mortgage professionals who are familiar with their Program. For more information about these programs you can contact the Home Down payment Gift Foundation at 1-888-856-4600 or visit their website at www.homedownpayment.org.
Washington State Housing Finance Commission
1000 Second Avenue, Suite 2700
Seattle, WA 98104-1046
(800) 767-4663 (Toll free in Washington State)