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 can 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. Even with these drawbacks, it is
often a smart move if this is your only option.
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 downpayment 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.
Other Resources:
Partners in Charity Program
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 the 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
Many local and state agencies run bond programs to
generate funds to help individuals and families with a down payment. Contrary to public
thinking, these bond issues are not a type of welfare. The government knows that it can be
tough to buy that first home, especially on a limited income.
Most agencies are income sensitive, but you may be
surprised by the high level of acceptable income. The income level is especially high if
you have children or dependents. Most agencies also have purchase limits, but they are
adjusted to the income qualifications level.
If you are able to obtain down payment assistance, you
may receive a lower interest rate. The drawback is that it often takes quite a bit of work
with extra paperwork and mandatory education classes. Our advice, find a realtor or
mortgage professional who is familiar with both the local and state agencies and their
policies.
Florida Housing Finance Agency
2571 Executive Center Circle East Tallahassee, FL 32399
(904) 488-4197
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