Question: “I want to buy a house, but I don’t have 20 percent saved up for a down payment. Are there any low down payment mortgage options for people who cannot afford the full 20 percent? And if so, what are the downsides of going that route?”
Yes, there are some ways to get a mortgage loan with a low down payment. But you’ll have fewer options today than in the past. VA and USDA loans offer 100 percent financing, which means the borrower doesn’t have to put any money down. The increasingly popular FHA loan program allows you to make a low down payment of 3.5 percent, if you meet all of the program guidelines. Also, depending on where you live, you might find a lender who offers 80-15-5 “piggyback” mortgage loans with a down payment as low as 5 percent.
Things Have Changed Since the Housing Crash
At the height of the housing boom, you could find plenty of low down-payment mortgage programs for buyers like yourself. Back then, lenders were doing everything they could to put people into loans — even if that meant relaxing their collateral requirements. Borrowers could also get approved with bad credit, undocumented income, etc. It was a real free-for-all.
You know the rest of this story. The reckless lending of the 90s and early 2000s helped fuel a housing crisis that brought down the economy like a house of cards. To say that lending requirements have changed since the housing crash would be an understatement. It’s a lot tougher to get approved for a loan today. Additionally, there are fewer options for low down payment mortgage loans. A government-backed mortgage might be your only option.
Here are some financing options to consider:
3.5 Percent Down on FHA Loans
This is by far the most popular option for low down payment mortgages. The popularity of FHA loans has surged since the housing market crashed. These loans are insured by the government, under the management of the Federal Housing Administration. You would apply for the program through a regular lender. In the event that you could no longer make your mortgage payments, the FHA would cover the lender’s losses. As a result of this added protection, lenders are more flexible with their down payment requirements.
FHA loans allow you to put as little as 3.5 percent down on the loan. But there’s a catch. You’ll need a FICO credit score of 580 or higher to qualify for the 3.5-percent down payment program. With a score below 580, you’ll have to put at least 10 percent down. Learn more
100 Percent Financing with VA and USDA Loans
It’s possible to get 100-percent financing when buying a home. This means the borrower has no down payment whatsoever. But these options are limited. The USDA and VA loans are the only option for 100-percent financing, at least at the national level.
These mortgages are only offered to a very specific audience. For example, VA loans are only available to members of the military and their families. USDA loans are offered to certain low-income borrowers in rural areas. Both of these programs qualify as low down payment mortgages.
You can learn more about VA loans at www.homeloans.va.gov. You can learn more about the USDA program in this article.
Low Down Payment with the “Piggyback” Strategy
Piggyback loans are another strategy for keeping your down-payment costs low. This is where you get one mortgage loan for the majority of the purchase price, and a second loan for a lesser amount of the purchase price. You would then pay the remaining amount in the form of a down payment.
The “80-15-5” mortgage loan is a good example of this strategy. Here, the borrower gets a loan for 80 percent of the purchase price. They get a second loan for 15 percent of price. The borrowers make a down payment of 5 percent to cover the remainder. In this scenario, the lenders provide 95 percent of the total cost. The buyer covers the rest. So this strategy can be used as a low down payment mortgage option. The downside is that you’ll have to pay extra for private mortgage insurance (defined below), since the first loan accounts for more than 80 percent of the purchase price.
The 80-10-10 piggyback loan is another popular option. The concept here is the same, but the amounts are different. The first and second loans account for 80 percent and 10 percent of the purchase price. The borrower make a down payment of 10 percent to cover the rest. This option helps you avoid private mortgage insurance (PMI), because the loan-to-value for both mortgages stays below 80 percent. See next section for more about PMI.
Low Down Payments Bring Extra Insurance
It’s important to understand the relationship between down payments, loan-to-value ratios, and mortgage insurance. If you put less than 20 percent down on a home, you’ll have to pay for private mortgage insurance / PMI. Unless, of course, you use the piggyback strategy explained above. So let me rephrase that. Anytime you have a home loan with a loan-to-value ratio above 80 percent, you have to pay extra for PMI coverage. You need to include this added cost in your decision-making process.
Do the math to find out which option saves you the most money, in the long run. It’s usually a trade-off between your up-front payment ability and the long-term cost of the loan. Check out the Mortgage Professor’s piggyback calculator. It will help you weigh your options.
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