For many young families looking to buy their first home, the notion of making a traditional 20% down payment can seem like a huge barrier to home ownership. However, today we’ll discuss different types of mortgages, loan products, and options that can help make your dream attainable even if you can’t afford a large down payment. If you’re worried about a 20% down payment barring you from becoming a home owner, read on to learn about your options.
Mortgage insurance premiums
While mortgage lenders have historically preferred a 20% down payment, there are numerous products and programs today that allow for prospective homeowners to secure a loan with little (or no) down payment. This is great news for individuals and couples with stable income, but little savings. However, when you make little or no down payment on your home, you’ll be assessed an ongoing fee in the form of mortgage insurance or “PMI”, which functions differently depending on your type of mortgage.
Mortgage insurance is essential for securing a loan and offers your lending institution financial protection. Mortgage insurance financially covers the lender in the event that the home owner defaults on their mortgage. The overall cost of mortgage insurance differs with each program, and can offer a relatively clear path to home ownership perhaps even without a down payment.
Calculating mortgage insurance premiums
A number of factors go into determining the cost of your mortgage insurance payments, from your credit score, to lending history, to income. First off, a lender looks at your credit as a baseline to assess the likelihood that you’ll be able to consistently make the payment on your mortgage. With better credit, the cost of mortgage insurance tends to decrease somewhat.
However, the main factor that dictates the size of your mortgage insurance fees is still the down payment. In short, if you make little or no down payment, your mortgage insurance will cost more because the lending institution is assuming greater risk and liability. Conversely, with a higher down payment, mortgage insurance costs commensurately less.
Private mortgage insurance
With conventional mortgages, PMI, or private mortgage insurance is required, which is often included in your regular monthly mortgage payment. This differs from mortgage insurance premiums assessed by federal programs. With PMI, the good news is that as you increase equity in your home, PMI lowers and eventually disappears when you’ve accumulated 20% equity.
If you pay down your mortgage loan faster than what the amortization schedule dictates, or if your home value appreciates such that you have more than 20% equity, you may be able to drop PMI sooner. Be aware, however, that this may entail submitting a request to drop PMI (in the case of faster loan pay-down) or even a new appraisal (in the case of appreciating home value).
Because mortgage insurance ultimately adds to the total cost of your home, it tends to get a bad reputation. However, if you have low or thin credit or can’t save up for a meaningful down-payment, it’s an option worth exploring. In addition to PMI through private lenders, there are also few different federal mortgage programs that you should know about when purchasing your home, especially if you’re a first-time property owner.
Federal Housing Administration loans (FHA loans):
Federal Housing Administration loans require a minimum credit score of just 580 and require a down payment of only 3.5%. If your credit score is a little lower than you’d like or your savings don’t allow for a meaningful down payment, then the FHA loan is a great option.
However, with FHA loans, you’re required to carry mandatory mortgage insurance. With FHA loans, a 1.75% mortgage insurance premium — which itself can be financed — is assessed upfront at the time of purchase. In addition to the 1.75% mortgage insurance premium, you’ll also be required to pay a monthly mortgage insurance premium for the life of the loan.
U.S. Department of Agriculture loans (USDA loans)
USDA loans help moderate- to low-income borrowers buy homes in rural areas with little or no down payment. These loans may only be used in certain USDA qualified areas, and you must meet certain income limits. USDA loans assess mortgage insurance in two ways, first in the form of a one-time fee when you take out the loan, which in 2019 is 1% of the total loan amount. Additionally, an annual fee of .35% of the remaining loan balance is assessed.
You can use this loan eligibility tool to see if you qualify for a USDA loan.
U.S. Department of Veteran Affairs loans (VA loans):
Active-duty and veteran military service members and/or their surviving spouses qualify for VA loans. VA loans are borrowed from private lenders but don’t require down payment and are guaranteed by the U.S. Department of Veteran Affairs. Instead, when you take a VA loan, you’ll be assessed a funding fee of 2.15% upfront in lieu of PMI, similarly to FHA and USDA loans. VA loans typically have lower interest rates than FHA loans, making them a very attractive option for service members.
In addition to these federal programs, you should check to see if you qualify for any local and state programs that help reduce the upfront costs of first-time home ownership. Take a look at this by-state list of programs, provided by NerdWallet.
A final word on mortgage insurance
PMI and other low down payment lending programs are a great option in that they make it possible for you to own a home, even without a 20% down payment. However, it’s important to note that you need to carefully calculate and take into account the overall cost of mortgage insurance throughout the life of your loan.
With a mortgage insurance premium, it’s also important to explore the big-picture financial implications and consider adjusting the size of your loan accordingly. As such, it’s essential to consult with a loan officer or trusted financial advisor to discuss which options makes the most sense for you and your family.
Are you feeling overwhelmed by the prospect of taking out a mortgage? Do you have specific questions about mortgages and your financial situation? Luckily, we can help.
For expert mortgage and financial guidance, Contact Holdfast Wealth Management today.