5 things buyers should know about low down payment options (Remember: Cash is ALWAYS King)

Many homebuyers confide in real estate agents and loan officers to find them the best price. But 95% agents don’t understand the value of knowing about all of the low down payment options available to their clients, says Gauri Nerurkar, Realtor DC Metro Homes Team of RE/MAX.

In fact, in a recent post for mortgage industry blog, MGIC Connects, that out of the most recent NAR Profile of Buyers and Sellers states, 40% of repeat buyers, and 66% of first-time home buyers, are putting less than 10% down. Understanding all of the low down payment mortgage options available to borrowers and leveraging this information to help them save money has the potential to positively impact your business growth.

Here are 5 reasons why we believe buyers need to know about low-down payment mortgage loans.

1. FHA IS MORTGAGE INSURANCE

Many people think that the Federal Housing Administration (FHA) provides a service that is markedly different than the service private mortgage insurers provide. The reality is both FHA and PMI provide the exact same service, but with some key differences.

2. PMI ALLOWS A BORROWER TO PUT LESS MONEY DOWN

A conventional loan with private mortgage insurance allows for slightly less money for a down payment (as little as 3% down), whereas FHA requires a 3.5% down payment. The ability to use gift funds is another low-down-payment option for borrowers. Many don’t realize that conventional loans with PMI do allow for the use of 100% gift funds.

3. FHA CAN LEAD TO MORE BORROWER DEBT

Even though a borrower may put less down using a conventional loan with private mortgage insurance, they still end up with less debt than borrowers who take out FHA loans. This is because FHA charges an upfront premium along with the monthly mortgage insurance amount. That upfront premium is most often financed into the loan, increasing the total amount borrowed. Keep this in mind when discussing low-down-payment options with borrowers who have higher credit scores, since they stand to gain more by going conventional.

4. CREDIT SCORE MAKES A DIFFERENCE

Most PMI premiums are based on credit scores, meaning the higher the borrower’s credit score, the lower the premium. FHA does not base its premiums on credit score, so borrowers with lower credit scores often find FHA a lower-cost option whereas borrowers with higher scores would save more money by going conventional.

5. FHA MORTGAGE INSURANCE CAN’T BE TERMINATED

One of the biggest concerns for low-down-payment borrowers relying on government mortgage insurance through FHA is that unless the borrowers put at least 10% down, they won’t be able to cancel their FHA mortgage insurance. One of the advantages private mortgage insurance offers is that it is a short-term solution. It is automatically dropped when the loan reaches 78% loan-to-value. Additionally, the borrower can request the private mortgage insurance to be cancelled once the loan reaches 80% of the original value, based on either the actual payments made, or the initial amortization schedule (for fixed rate loans) or current amortization schedule (adjustable rate loans), irrespective of the actual loan balance.

When you know as much as possible about borrowers’ low-down-payment options, you can discuss them with your Realtor and/or your Loan Officer and choose the best option.

Many first time buyers have no idea that going out and buying a car after applying for a home mortgage could end up costing them their dream home!

 

Understanding FHA Loans

Here’s what you need to know about the government program

Federal Housing Administration (FHA) loans often confuse people because the FHA does not make loans. Instead, it insures the loans made by lenders it has approved. This means if the borrower defaults, the FHA, which is a government program, will cover the losses.
Historically, the FHA allows some of the most liberal lending standards in the market and is often a good fit for first-time buyers, those with small down payments and those with less-than-perfect credit. But anyone is eligible to apply.
The FHA is also not a product for everyone and not all lenders offer FHA loans. But many do and you can find FHA lenders at its
Here’s a look at the pros and cons of FHA insured loans:Pros

  • Down payment. The minimum down payment is 3 percent and the FHA allows the money to come from a family member, charitable organization or even an employer. Most conventional loans require the borrower to prove he has the down payment amount.
  • Interest rate. FHA loans usually offer a lower interest rate because it allows a smaller down payment and lower credit scores. Lenders of conventional loans see more risk in a comparable loan and, so, have a higher interest rate.
  • Weak credit: Those with credit problems, even a bankruptcy, may be able to qualify for an FHA loan. The FHA puts more emphasis on income, length of employment and job security than do lenders of conventional loans.
  • Higher ratios. The FHA allows a ratio of 29 percent — of mortgage payment to income (divide the mortgage payment by gross monthly income.) –- or 41 percent -– of all monthly debt to income (divide all your monthly debt such as auto loans and credit card payments by gross monthly income.) Conventional loans usually only allow 28 percent and 36 percent, respectively.
  • No prepayment penalty. The FHA does not allow prepayment penalties, which some conventional loans require if you pay off the loan early. This penalty is charged because lenders are trying to keep people from habitually refinancing. Usually, lenders waive the penalty if the home is sold.
  • Loans for multi-unit properties. FHA loans are not just for single-family homes and condos. They are also available for 2- to 4-unit multi-family complexes. There is also a special loan program for buying a fixer (203k) that includes amounts to make the needed repairs.
  • Closing costs. The FHA allows closing costs to be included in the loan as long as the borrower qualifies for the higher amount. Most conventional loans require that closing costs be paid for at the close of escrow and not be part of the amount loaned.
  • Canceling MIP. The FHA has specific requirements that when met will allow you to cancel you Mortgage Insurance Premium. It is usually more difficult to cancel the Private Mortgage Insurance that is charged under conventional loans with a less than 20 percent down payment.

Cons

  • Higher mortgage insurance. FHA loans require a Mortgage Insurance Premium (MIP), which is similar to the Private Mortgage Insurance charged in conventional loans with less than a 20 percent down payment. The FHA MIP requires paying 1.5 percent of the loan amount up front and .50 percent of the amount owed annually, but paid monthly. (i.e.: A $100,000 loan balance will cost $500 the first year or $41.67 per month). PMI on conventional loans is usually less expensive.
  • Loan limits. The FHA has limits on the amount that can be borrowed because the program is designed for low- to moderate-income buyers. These limits are based on where the house is located. These limits can be changed at any time, so it’s best to check the FHA Web site for the latest information on your area.
  • Must be owner-occupied. An FHA loan requires the home, or one unit in a multi-family complex, be occupied by an owner. So, this program is not for investors looking to buy property to rent out.
  • Limits lender fees. The FHA sets limits it will allow lenders to charge. If the lender charges more, the seller has to agree to pay the additional costs. This can make a prospective buyer with an FHA loan less attractive.
  • Takes more time. FHA loans require more time to complete. In hot markets or in the case of multiple offers, an offer from a buyer wanting an FHA loan may not be considered as strong as an offer from a buyer with a conventional loan.

The Power of Assumability

One of the rarely touted advantages of people taking FHA mortgages today is the fact that they are assumable. What that means is, when the FHA home buyer of today is looking to sell his home, a qualified purchaser can “take over” their loan.

Most people believe that interest rates will return to a “normal” range (around 7%) in a couple of years. When you assume a mortgage, the terms remain the same. This means that a buyer five years from now can enjoy a 3.5% mortgage by assumption rather than the 7% mortgage they would get without it. Since most people buy homes based on how the monthly payment fits into their personal monthly budget, this is extremely impactful.

As an example, a $500,000 loan at 3.5% today carries with it a $2,250.00 mortgage payment on a 30 year fixed mortgage. If offered for sale in five years, the purchaser could assume the $448,485.36 balance with the same $2,250.00 payment and remaining term of 25 years. The total payments over the 25 years would be $675,000.

Compare that to a new $450,000 loan at 7% for 25 years, which would carry a monthly payment of $2997.00 (over $750 more a month than the assumption and more than $225,000 more over the 25 year term).

At 7% for 25 years, to wind up with the same payment as the assumed mortgage, our borrowers would only be getting $338,000…$162,000 LESS!

The point here is that, when rates go up, homes with assumable mortgages will have more value and will sell at higher prices because they are more affordable. As an additional bonus, the closing costs on assumable mortgages are significantly less.

The borrowers must be credit-worthy of course (have good credit, qualifying income,  & necessary assets to close), but they would have to be credit-worthy to get a new mortgage too!

Besides the multiple other reasons to obtain an FHA mortgage (low down payment requirements, extended income ratios, lower credit scores, and easier sourcing of funds), there is another perk. In the future, there is a good chance that you may be able to sell your home for more money because of the FHA loan’s assumability.