Finding the right mortgage for you
Smaller down payments are still possible (if you meet the requirements), but homebuyers should shop around for the right mortgage for their finances.
Smaller down payments are still an option if you meet the requirements, depending on the lending institution.
While some Millennials are dealing with student loan debt and lack the cash to opt for a traditional 30-year mortgage requiring a 20% down payment, Federal Housing Administration (FHA) loans remain an option.
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FHA loans were the dominant choice among many first-time home buyers until recently. With a loan from the FHA, buyers have the option to finance 96.5% of a home's price and put just 3.5% down.
Unlike conventional financing, 100% of the down payment could be a gift, so borrowers are able to secure a loan without putting any of their own money down, said Malcolm Hollensteiner, director of retail lending products and services at TD Bank, a financial institution based in a Cherry Hill, N.J. One advantage is that the underwriting criteria are more flexible than conventional mortgage loans.
While those factors are appealing to many borrowers, the FHA has increased its mortgage insurance costs which makes this type of loan more expensive for the buyer and has led to the number of first time buyers who obtained FHA loans to drop dramatically.
While many home buyers are still seeking the FHA loan, it is not as popular since the monthly mortgage insurance rates have risen, said Sin-Yi Lamberston, real estate and mortgage broker at ERA Yes! in Glendora, Calif. However, FHA loans allow consumers to borrow more with a lower credit score.
If you have less than the 20% down payment, you can obtain private mortgage insurance or PMI to purchase a home.
PMI insurance allows a maximum loan to value of 95% of a home's purchase price, although some PMI loans will insure 97% loan to value for certain lenders, said Hollensteiner.
The draw for borrowers is that it is cheaper compared to an FHA loan. In conventional financing with a low downpayment, buyers will either pay a monthly insurance cost or an upfront mortgage premium; however, with a FHA loan, buyers will pay both.
With recent FHA rule changes, regardless of how much equity a borrower builds in a property, the borrower will have to continue to pay the mortgage insurance premium. With conventional loans, the borrower can cancel mortgage insurance once enough equity is built in the property, but with an FHA loan borrowers will have to refinance into a conventional loan in order to cancel the mortgage insurance, he said.
Consumers can avoid paying PMI by qualifying for piggyback loans or the "80/10/10" loans which only require a 10% down payment. TD Bank offers an 80/10/10 piggyback loan for both conventional and jumbo buyers in which a borrower will put down 10%, take out the first mortgage for 80% and take out a second loan for the remaining 10% of a home's purchase price, said Hollensteiner.
The traditional 30-year mortgage loan is the best option for many home buyers, especially Millennials, said Lamberston.
"People should not over leverage," she said. "I'm seeing a lot of people who want the best of everything, but set your sights realistically. Start with a smaller home and build up sweat equity and remodel it yourself."
One of the best things consumers can do while they are determining whether to purchase their first home is to protect their credit score so they can obtain the best mortgage rate, said Lamberston. "Watch and protect your credit," she said. "Don't buy things because you have a credit card and can charge on it. Instant gratification is very costly. It will really hurt you. Don't live for the moment. Have a little long-term vision."
Check with the lending institution to see if they offer any special mortgages. For instance, TD Bank offers their "Right Step" mortgage program that offers qualified home buyers an alternative to the FHA backed loan products.
"Borrowers can secure a loan with a 5% down payment; however, Right Step also allows the buyer to receive as much as 2% of the home's sale price as a gift from a relative or other third party, so buyers really only need 3% down," said Hollensteiner.
The government has various other options, depending on where you live. USDA and Rural Housing Authority loans also allow eligible borrowers to finance 100% of a home's purchase price if it is defined as a rural housing area. State bond programs offer below market rate programs through conventional mortgage lenders. Buyers can find these programs throughout the U.S. through their state or local housing finance authority.
"As FHA mortgage insurance premiums increase, borrowers are looking to these programs for a more affordable option," he said. "It's important to keep in mind that most states don't insure the loan so a borrower will still need to combine the state bond loan with either a conventional loan with PMI or an FHA, VA or USDA Rural Housing loan."
Home prices in many cities have already risen and some have surpassed the recession lows, so trying to time the market can be a risky idea.
"Buy the best you can afford comfortably," Lamberston said. "Put your foot in the door and don't let inflation beat you down."
Construction loans can benefit home buyers who need to put down a smaller down payment, but can live with an unfinished bathroom or kitchen.
Renovation loans like the FHA 203K or Fannie Mae's HomePath allow buyers to finance the cost of renovations so they can update an older home in an affordable neighborhood, said Denise Pajak, vice president at Private Mortgage Solutions, an Atlanta-based lending institution.
"Construction loans allow buyers to tear down and rebuild exactly how they want," she said. "They only require a 3.5% to 5% down payment. Buyers can pick out finishes like tile and light fixtures, so the home has their own touch."
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Keep in mind that these are the minimum down payment requirements set by Fannie Mae, HUD / FHA, VA, and USDA Rural Development. Mortgage lenders have the right to require larger down payments at their discretion, and typically will do so for borrowers with lower credit scores, higher debt-to-income ratios, etc. To quickly locate lenders that have no "overlays" that would could require higher down payments based on a given scenario, visit RateBid.com and post your mortgage request. Not only will you be introduced to mortgage lenders that believe they can accommodate a given scenario, potential borrowers remain anonymous while lenders are encouraged to engage in "bidding wars" between each other (which adds an element of entertainment I guess). This reverse auction website for mortgages has no "winning bidder". The site ultimately lets borrowers "zero in" on lenders that think they could approve a given mortgage request and, out of these lenders, which ones can offer the best rates-- without ever receiving a single sales call.