In the years following the housing crisis, there weren’t very many lenders offering conventional mortgage loans with 3% down payments. But that has changed. Today, an increasing number of lenders are peddling loans with down payments as low as 3%.
This is largely the result of recent changes within the secondary mortgage market. Fannie Mae and Freddie Mac will now purchase conventional mortgages with loan-to-value ratios as high as 97%. Conversely, that means the home buyer / borrower can make a down payment as low as 3% on such a loan.
Conventional Mortgages With 3% Down: Two New Programs
Toward the end of 2015, Freddie Mac (one of the two “government-sponsored enterprises,” or GSEs, that buy and sell mortgage loans) announced it would begin purchasing conventional mortgage products with a loan-to-value ratio up to 97%. In the past, it was rare for the company to acquire such loans.
This is a major shift since Freddie Mac’s guidelines tend to “trickle down” to the primary mortgage market in general. Lenders tend to originate mortgage loans that fall within the purchasing parameters of Freddie Mac and/or Fannie Mae, so that they can turn around and sell their loans to the GSEs.
According to a company bulletin that announced the change, Freddie Mac is broadening its parameters in order to “help expand access to mortgage credit.” That’s mighty benevolent of them. But it doesn’t hurt that they’ll be making a lot more money this way, by expanding their asset pool.
The Freddie Mac product is called Home Possible Advantage. It will be available for home loans with settlement dates on or after March 23, 2016. Borrowers who use this program could qualify for a conventional mortgage loan with a 3% down payment. Manually underwritten borrowers need to have a credit score of 660 or higher and participate in a homeowner education program. Additionally, the borrower’s “annual qualifying income must not exceed 100% of the area median income or the income multipliers in the designated high-cost areas.”
Not to be outdone by (or to lose business to) its GSE counterpart, Fannie Mae also announced it will acquire conventional mortgage loans with down payments of 3%. In a product fact sheet published in November of last year, Fannie Mae outlined the requirements for 97% LTV mortgages. Many of the high-LTV loans the GSE purchases will fall under its HomeReadyTM product umbrella. The requirements for HomeReady include income limits similar to Freddie Mac’s parameters, as well as homeowner education and counseling.
As a result of these ongoing changes within the mortgage market, we expect to see expanded opportunities for borrowers seeking a conventional home loan with a 3% down payment. Just realize that most of these loans require additional insurance, and the cost of this insurance is borne by the borrower. So let’s talk about that next.
PMI Is Required in Most Cases, Unless…
Borrowers seeking a low-down-payment home loan must consider the added cost of mortgage insurance. If you make a down payment of 3% on a conventional home loan, there’s a good chance you will have to pay for private mortgage insurance, or PMI. This insurance protects the lender who makes the loan, but it is paid for by the borrower. Thus, PMI can increase the size of a borrower’s monthly payments.
The Freddie Mac and Fannie Mae 97% LTV products mentioned above require some level of PMI. (You’ll find those insurance requirements in the fact sheet and bulletin hyperlinked above.)
Generally speaking, a loan-to-value ratio above 80% requires PMI. This means that most borrowers who take out a conventional mortgage loan with a 3% down payment will end up paying PMI — at least in most cases. But there are a few programs out there that allow home buyers to sidestep the added cost of PMI, even with a down payment as low as 3%.
We have previously reported on such programs, including some offered by credit unions. But even the “big banks” are getting in on the game. Bank of America is the most recent (and newsworthy) entrant into the 3% down payment market. The company recently positioned itself as an attractive alternative to FHA financing by offering a 3% down payment without PMI, for qualified borrowers. A credit score of 680 or higher is required, according to the company.
According to American Banker magazine, Bank of American will turn around and “sell the loans and servicing rights to Self-Help Federal Credit Union, a Durham, N.C., community development lender…”
The bottom line is that home buyers seeking a conventional mortgage with a 3% down payment have a lot more options these days. And some are available without PMI. This is certainly a trend we will be monitoring in 2016, as it could affect a large number of home buyers.