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What does your most affordable path to homeownership look like?
Pre-COVID, it was standard practice to aim for 20% of your home’s purchase as a down payment. But the economic conditions brought on by COVID-19 caused financial institutions to tighten their belts and, and now 20% is all but a requirement for most conventional mortgages.
Where does this leave people looking to buy a home during a pandemic? Options still exist. There are various no down payment mortgage options available today, particularly for government-sponsored loans, and several low down payment options.
“That’s why it’s important for people to research all lending options,” says Brian Rubenstein, senior director at Ally Home, the mortgage lending division of Ally Financial. With some lenders increasing down payment standards, some lenders may not require it, Rubenstein says.
Of course, even if you find a no money down mortgage, you still need to be ready to take on the cost of homeownership.
“These vehicles help you achieve homeownership when you otherwise couldn’t. But it still boils down to: can you afford the monthly payment long-term?” says Michael Chabot, SVP of residential lending at Draper & Kramer Mortgage Corp., a national real estate lending firm.
First, a Note on PMI
Before you research your low- or no-down-payment options, it’s essential to understand PMI, or private mortgage insurance. PMI is an additional payment lumped into your mortgage loan that typically applies when you put down less than 20% on a new home. This works as insurance to your lender since financing more than 80% of the home’s value is considered risky.
“PMI payments can average between $150-$500 extra per month. That’s money you’re losing in order to protect the lender, not yourself,” says Chris Hogan, a personal finance expert at Ramsey Solutions, the financial counseling and education company founded by author Dave Ramsey. When choosing a zero or low down payment loan, it’s critical to factor in PMI into the equation to make sure you are getting a good option.
“I tell people to avoid PMI at all costs,” says Hogan.
The Pros and Cons to Low- or Zero-Down Payment Mortgages
It’s true low- or zero-down payment options can bridge the gap to homeownership for those who want to buy but cannot afford a large amount upfront. But putting less than 20% down on a house comes with its advantages and disadvantages. Here are the broad strokes to keep in mind as you weigh your options.
|Easier to buy for those without a 20% down payment saved||With zero or low down payment, it takes longer to earn significant equity|
|Keeps more of your money liquid, so you have cash on hand||Less than 20% is a higher risk, which can result in yo paying a higher interest rate|
|Buying sooner means your housing costs build equity (Compared to renting)||PMI payments can be an extra financial burden|
|Tax benefits (mortgage interest is deductible)||Increased risk of getting into more house than you can afford|
|Shortens time needed to save for a down payment||Higher monthly payments because you’re financing more of the house|
Zero-Down Mortgage Loan Options
Options for zero-down payment mortgages.
If you’re looking for a zero-down mortgage with no PMI, a USDA loan might be the way. These loans are backed by the USDA (U.S. Department of Agriculture) and are designed to help low-income families find homeownership more accessible.
To get the perks of this loan, though, you need to meet certain requirements.
Primarily, you need to have an adjusted income below the county’s limit where you want to buy. Each county has income qualification limits, which is updated often through the USDA website. Keep in mind, if your income exceeds the county limit where you want to purchase a home, you will not qualify. To find out if the place you want to buy qualifies, use this property eligibility tool from the USDA.
To qualify for a USDA home loan, you also need to buy your home in a rural area. When you think of rural, you may not realize that includes many suburban areas too. In fact, 97% of U.S properties qualify as “rural” for this type of loan.
Take note: with this option, refinancing to a better interest rate is not an option, and there may be prepayment penalties, says Hogan.
This is a zero down payment mortgage option for military families to explore. The VA loan is backed by the Department of Veterans Affairs and is for current and former military members or their surviving spouses. If you meet these eligibility requirements, a VA loan can be a choice for veterans seeking homeownership. “VA loans are the best loans in the marketplace. It has no money down and no mortgage insurance,” says Chabot.
You may be able to avoid PMI with a VA loan, but you could also incur additional fees you otherwise would not see with a conventional mortgage, says Hogan. If you’re a veteran and have 10%-20% for a down payment, you may be better off getting a conventional loan with a better interest rate anyways, he continues.
Doctor Home Loans
Also called a physician loan, this isn’t a guaranteed option for zero-down home loans, but it’s worth exploring if you’re a physician, nurse, or healthcare worker. If you qualify, you could see a zero-to-low down payment with no PMI. Doctor home loans vary by state, so figure out your options based on where you live.
Low Down Payment Loan Options
Zero-down mortgage options are limited. But it doesn’t mean you need to cough up 20% down for your home purchase. In fact, there are quite a few low (think: between 3 and 5%) down payment options.
FHA loans can offer lower down payment options plus more relaxed credit requirements, making this type of loan another alternative path to homeownership.
Backed by the Federal Housing Administration (FHA), you may get one of these loans with as little as 3.5% down.
There are thousands of down payment assistance programs available, but they vary based on your location. Research your state and county to see if you qualify.
FHA loans are especially popular with first-time homebuyers. Be advised you will have to pay PMI with this option for the full mortgage term. Also, FHA loans come with eligibility requirements such as a minimum credit score of 580, a debt-to-income ratio below 43%, and proof of steady income.
HomeReady and Home Possible Mortgages
“There are two different programs that are offered for first-time homebuyers specifically: HomeReady and Home Possible,” says James McCann, senior loan officer at Modern Lending Team, a California-based mortgage lender. Home Ready is available through Fannie Mae, while Home Possible is available through Freddie Mac.
HomeReady and Home Possible are conventional mortgages specifically designed for first-time buyers and will allow 3% down. Unlike government-backed loans like VA or USDA mortgages, conventional mortgages come from private lenders such as banks or credit unions. Some conventional loans can be backed by either Freddie Mac or Fannie Mae, two entities sponsored by the government.
“It’s still 3% down, but they give you a little bit of a break on an interest rate and, typically, on the private mortgage insurance,” McCann says. “Both of these programs have an income limit that’s address-specific.” To figure out if you’re eligible for a HomeReady mortgage, use this map to find the income max in your area. Home Possible offers a similar tool.
Conventional 97 Mortgage
A conventional 97 mortgage is named due to the fact they cover 97% of the home’s purchase price with a low down payment of only 3% down. They are available through Freddie Mac or Fannie Mae. Recently updated, the newer version of conventional 97 mortgages is available to first-time homebuyers or those who have not owned in the last three years.
Typical income and employment verifications apply as they do for most private loans.
With this option, you will have to use PMI and might have a higher interest rate compared to some of the other federally-backed options, warns McCann. Although PMI can be cancelled later when you reach enough equity.
Down Payment Assistance Options
The zero money down or low down payment options are not the only way you can buy a house without 20% cash in hand. There are some other options to explore than can cover the down payment.
First, it’s well worth your time to look into your state and county’s down payment assistance programs. “Down payment assistance programs are great for people who make good money and have great credit but haven’t been able to save a ton over the years,” says McCann. “It’s solving the missing asset piece.”
Some of these programs will issue you a grant for your down payment, while others offer loans to cover your down payment with a loan that may be forgivable.
As you consider buying with a no money down mortgage, a low down payment option, or down payment assistance, make sure you don’t get into more house than you can afford. “Your house has the potential to become a burden instead of a blessing,” says Hogan.
Whichever option you choose, make sure the monthly mortgage payments will be comfortable while leaving enough savings to cover the unexpected expenses that come with homeownership.
Many experts recommend paying down your debt and having an emergency fund of 3-6 months worth of expenses before jumping into any mortgage loan option.