How to Buy a Home With a Low Down Payment
A consumer�s guide to owning a home with less than three percent down.
If you�re dreaming of buying a home, congratulations.You�re in good company! About two-thirds of thenation�s households own their own home.
This brochure describes how families can get intotheir own homes with little cash up front. It explainsmortgage insurance and how it works, and looksat the two options � private mortgage insuranceand government mortgage insurance.
|WHY BUY A HOME?|
Homeownership remains one of the highest goals for many people becauseof its many benefits. Along with owning a home comes a sense of securityand belonging that cannot be found elsewhere. For many, homeownershiprepresents personal and financial success.
There is much personal satisfaction in living in a home that you own. Ahome is a valued investment that can have many financial advantages andtax benefits. The interest you pay on a home loan and the real estate taxesyou pay on your home are among the few major federal tax deductions.Owning a home is the primary way most people build wealth.
Homeownership is also good for our communities, because families whoown their homes are more involved in their communities and participate inlocal events.
The rewards of homeownership include:
OBSTACLES TO HOMEOWNERSHIP
Still, for many Americans, owning a home continues to remain just slightlyout of reach. For more and more families, saving the money for a downpayment is the biggest obstacle to homeownership. Many people mistakenlybelieve that you have to come up with a down payment equal to 20 percentof the price of a home.
Traditionally, lenders have required that home buyers be able to make adown payment of at least 20 percent of a home�s purchase price to get ahome loan or mortgage. Mortgage lenders, however, will grant home loansto qualifying home buyers with a down payment of as little as 3 to 5 percentof the purchase price if the mortgage is insured.
In fact, home loans with down payments of less than 20 percent arebecoming increasingly popular. They are called �low down paymentmortgages.�
This is good news for the millions of home buyers who are finding itdifficult to save a large down payment, especially for their first house.
MANY PEOPLE MISTAKENLY BELIEVE THAT YOU HAVE TO COME UP WITHA DOWN PAYMENT EQUAL TO 20 PERCENT OF THE PRICE OF THE HOME.
|WHAT MAKES A LOW DOWN PAYMENT POSSIBLE|
Simply put, mortgage insurance protects the mortgage lender against financialloss if a homeowner stops making mortgage payments. Lenders usuallyrequire insurance on low down payment loans for protection in case the homeownerfails to make his or her payments. When a homeowner does not makemortgage payments, a default occurs and the home goes into foreclosure. Boththe homeowner and the mortgage insurer lose in a foreclosure. The homeownerloses the house and all the money he put into it. The mortgage insurerhas to pay the lender�s claim on the defaulted loan.
For this reason, it is crucial that the family buying the home can really affordit � not only when they buy it, but throughout the time period of the loan.
Although the cost of mortgage insurance is paid by the home buyer, orborrower, the mortgage insurer works directly with the lender. Mortgageinsurance is available to commercial banks, mortgage bankers and savings& loans, all of which 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 anoutstanding mortgage balance if the person who took out the insurancepolicy dies.
THE SECONDARY MARKET
The lender�s decision to use mortgage insurance is driven by the requirementsof investors in the mortgage market. Because of the losses thatcould occur, major investors require mortgage insurance on all loans madewith low down payments.
The three primary investors in home loans are the Federal NationalMortgage Association (Fannie Mae), Federal Home Loan MortgageCorporation (Freddie Mac) and Government National MortgageAssociation (Ginnie Mae). By purchasing and selling residential mortgages,Fannie Mae and Freddie Mac help keep money available for homesacross the country.
Unlike Fannie Mae and Freddie Mac, Ginnie Mae does not actually buythe mortgages. It adds the guarantee of the full faith and credit of the U.S.government to mortgage securities issued by private lenders.
THE TWO CHOICES: GOVERNMENT INSURANCE ANDPRIVATE INSURANCE
Now that we have explained how mortgage insurance works and why it isnecessary, let�s look at the basic kinds of mortgage insurance. Low downpayment mortgages can be insured in two ways � through the governmentor through the private sector.
Mortgages backed by the government are insured by the FederalHousing Administration (FHA) or guaranteed by the Department ofVeterans Affairs (VA) or the U.S. Department of Agriculture�s RuralHousing Service (USDA-RHS).
The minimum effective down payment FHA requires is less than 3 percent.For single-family homes, there is a limit on the loan amount that variesaccording to geographic area.
Although anyone can apply for FHA insurance, the other two governmentmortgage guarantee programs are much more targeted. The VA program islimited to qualified, eligible veterans and reservists. The USDA RuralHousing Service insures loans for the construction and purchase of homesin rural communities. These programs are very specialized, so contact yourlender for details.
EARLY ON IN THE HOME-BUYING PROCESS, IT IS A GOOD IDEA TOMEET WITH SEVERAL LENDERS TO COMPARE THE TYPES OF MORTGAGESTHEY OFFER AND SHOP FOR THE BEST PRICE AND TERMS.
Obtaining conventional financing is the alternative to obtaining a homeloan backed by the government. Conventional mortgages are all homeloans not guaranteed by the government, including those guaranteed byprivate mortgage insurers.
Although both government and private insurance are based on the conceptof allowing families to get into homes with less cash down, there are manydifferences between the two. Often the lender or loan originator will play animportant role in suggesting and deciding which insurance is selected.
Private mortgage insurance is available on a wide variety of low downpayment home loans and there is no pre-set limit on the loan amount.Although differences such as these may affect whether the lender prefers towork with government or conventional mortgages, your lender will discusswith you which one would be better for your situation.
With the wide variety of loans available, home buyers have the freedomto choose the type of loan that best suits their needs. Early on in the homebuyingprocess, it is a good idea to meet with several lenders to comparethe 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 yourloan is insured by the FHA or a private mortgage insurer � because yourlender handles all of the arrangements.
By making lending money to home buyers safer, mortgage insurancehelps more families get into homes of their own.
|QUALIFYING FOR A LOWDOWN PAYMENT LOAN|
Qualifying for a low down payment loan is much like applying for aregular loan.
To be considered for a low down payment loan, you generally need to have:
Closing costs, or settlement costs, are paid when the home buyer andseller meet to exchange the necessary papers for the house to be legallytransferred. On average, closing costs run 2 to 3 percent 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, recordingfee, title search and insurance, tax adjustments, agent commissions,mortgage insurance (if you are putting less than 20 percent down) andother expenses. Your lender will give you a more exact estimate of yourclosing costs. You can eliminate the need to pay a year�s mortgage insurancepremium at closing by choosing a monthly premium program.
Points are finance charges that are calculated by the lender at closing.Each point equals 1 percent of the loan amount. For example, two pointson a $100,000 loan equal $2,000. Lenders may charge one, two or threepoints in up-front costs in addition to the down payment. The more pointsyou pay, the lower your interest rate will be. In some cases, you may be ableto finance the points.
SO HOW MUCH OF A MORTGAGE CAN YOU AFFORD?
There are two basic formulas commonly used by lenders to determine howmuch of a mortgage you can reasonably afford. These formulas are calledqualifying ratios because they estimate the amount of money you shouldspend on mortgage payments in relation to your income and other expenses.
It is important to remember that the following ratios may vary fromlender to lender and each application is handled on an individual basis,so the guidelines are just that � guidelines. There are many affordablehousing programs, both government and conventional, that have morelenient requirements for low- and moderate-income families. Many of theseprograms involve financial counseling to help potential home buyers learnabout the financial responsibilities of owning a home.
Generally speaking, to qualify for conventional loans, housing expensesshould not exceed 26 to 28 percent of your gross monthly income. For FHAloans, the ratio is 29 percent of gross monthly income. Monthly housingcosts include the mortgage principal, interest, taxes and insurance � oftenabbreviated PITI. For example, if your annual income is $30,000, your gross monthly income is $2,500, and $2,500 x 28 percent = $700. So youwould probably qualify for a conventional home loan that requires monthlypayments of $700.
IT IS IMPORTANT THAT YOU SELECT A HOME THAT WILL MEET YOURFAMILY�S NEEDS AND KEEP YOU HAPPY FOR YEARS TO COME.
Any expenses that extend 11 or more months into the future, such as acar loan, are termed long-term debt. Total monthly costs, including PITIand all other long-term debt, should equal no more than 33 to 36 percent ofyour gross monthly income for conventional loans. Using the same example,$2,500 x 36 percent = $900. So the total of your monthly housing expensesplus any long-term debts each month cannot exceed $900. For FHA loans,the ratio is 41 percent.
Maximum allowable monthly housing expense:
26�28 percent of gross monthly income � conventional
29 percent of gross monthly income � FHA
Maximum allowable monthly housing expense and long-term debt:
33�36 percent of gross monthly income � conventional
41 percent of gross monthly income � FHA
One way to determine how much to spend for housing is to compareyour monthly income with monthly long-term obligations and expenses.Use the worksheet, �Evaluating Financial Resources,� to determine howmuch money you can spend on housing. Be sure to include only income youcan definitely count on.
When budgeting to buy a home, it is important to allow enough moneyfor additional expenses such as maintenance and insurance costs. If you arepurchasing an existing home, gather information such as utility cost averagesand maintenance costs from previous owners or tenants to help youbetter prepare for homeownership.
Homeowner�s insurance or property insurance is another cost you willhave to consider. The lending institution holding the mortgage will requireinsurance in an amount sufficient to cover the loan. To protect the full valueof your investment, however, you might want to consider purchasing insurancethat provides the full replacement cost if the home is destroyed. Someinsurance provides only a fixed dollar amount, which may be insufficient torebuild a badly damaged house.
WHAT KIND OF PROPERTY CAN YOU BUY WITH A LOWDOWN PAYMENT LOAN?
There are a few restrictions on the type of home you may buy with a lowdown payment loan. In addition, low down payment loans may be usedwith a wide variety of mortgages.
Besides price range, there are many other factors to consider whenpurchasing a home. It�s in your best interest to take care in selecting ahome that will have lasting value as well as provide shelter. Be sure theneighborhood and house meet the needs of your family. If you have children,you may want to know if there are other children in the neighborhoodand what schools or playgrounds are nearby. Also consider the availability of public transportation and how far family members willhave to commute to work or school.
Check the condition of the plumbing, heating and electrical systems andwhether they are up to regulatory codes. The best and easiest way to do thisis through a home inspection from a certified inspector.
If you are like most people, a home is the single largest purchase you willever make. It is important that you select a home that will meet your family�sneeds and keep you happy for years to come. And most important, you mustbe able to afford to remain in that home for as long as you please.
YOUR INITIAL MEETING WITH A LENDER
The loan approval process generally begins with an initial meeting at whichthe prospective home buyer and the lender discuss the potential loan. Youwill need to bring information to verify your income and long-term debts.
Often people prefer to meet with the lender before house hunting todetermine in advance what price range they can realistically afford andthe mortgage amount for which they can qualify. This step is called prequalificationand can save you much time and trouble by assuring you arelooking in the appropriate price range.
For your first meeting with the lender, you should bring:
Having these items on hand when you visit the lender will help speed upthe application process. Usually, you will need to pay an application fee andappraisal fee when you submit the mortgage application. This is done onlyafter you have negotiated successfully on a home and the seller has acceptedyour offer. Generally, there is no fee for prequalification.
After the initial meeting with the lender, you should have a general ideaif you qualify for the size and type of loan you want. The lender should letyou know if you qualify for the loan in 30 to 60 days. If you are denied ahome loan, the lender must explain the reasons. If this happens, the lenderusually will discuss any options with you.
MORE AND MORE BORROWERS ARE TAKING ADVANTAGE OF LOWDOWN PAYMENT MORTGAGES AND BECOMING HOMEOWNERS WITHLESS THAN 3 PERCENT DOWN.
TWO KEY FACTORS IN QUALIFYING FOR A HOME LOAN
In attempting to approve home buyers for the type and amount of mortgagethey want, lenders basically look at two key factors: the borrower�s abilityand willingness to repay the loan. Ability to repay the mortgage is verifiedby your current employment and total income. Generally speaking, lendersprefer for you to have been employed at the same place for at least twoyears, or at least to have been in the same line of work for a few years.
The borrower�s willingness to repay is determined by examining how theproperty will be used. For instance, will you be living there or just rentingit out? Willingness also is closely related to how you have fulfilled previousfinancial commitments, thus the emphasis on the credit report or rent andutility bills.
It is important to remember that there are no rules carved in stone. Eachapplicant is handled on a case-by-case basis. So even if you come up a littleshort in one area, perhaps one of your stronger points will make up for theweak one. Everyone involved in real estate is in the business of sellinghomes, in one way or another. Therefore, if the loan makes sense, lendersand insurers will do their best to see that you qualify.
By its very nature, mortgage insurance is an aid to affordability, because itallows families to buy homes with less cash on hand. The industry plays a centralrole in helping low- and moderate-income families become homeowners.
More and more borrowers are taking advantage of low down paymentmortgages and becoming homeowners with less than 3 percent down. Formore information on how you can take advantage of the benefits of a lowdown payment home loan with mortgage insurance, contact your locallender or real estate agent. For general information on purchasing a home,contact the county extension office of the U.S. Department of Agriculture,listed in the government pages of your telephone book.
|MONTHLY PAYMENT FOR EACH $1,000 BORROWED|
|Note: Chart represents principal and interest only. |
This table helps you calculate your monthly housing costs, not including taxesand insurance. For example, assume you have a 30-year mortgage and the interestrate is 8 percent. The chart shows that the monthly payment amount per $1,000is $7.34. If you want to borrow $75,000, you can estimate the payment bymultiplying 75 x $7.34, which equals $550.50 per month. As you can see, thelower the interest rate, the easier it is to afford a home.
|EVALUATING YOURFINANCIAL RESOURCES|
PDF Format of Worksheet
|STEP 1: DETERMINE NET MONTHLY INCOME |
GROSS MONTHLY INCOME
Gross base pay (all wages and salariesother than overtime)
Net profit (from business)
Interest and dividends
Total gross income (add)
| $ |
Income tax (federal, state and local)
Insurance (life, health and property)
Total deductions (add)
1 Total take-home paySubtract deductions from income
| $ |
|STEP 2: FIGURE LONG-TERM MONTHLY OBLIGATIONS(MORE THAN 11 MONTHS) |
Installment payments (car, furniture)
Total long-term debt (add)
2 Subtract long-term debt from totaltake-home pay. Bring forward thenumber from Step 1.
| $ |
|STEP 3: MONTHLY NONHOUSING EXPENSES |
Food, beverages (home and work)
Clothing and grooming
Insurance (life and health)
Gifts and charity
Entertainment and recreation
Total monthly nonhousing expenses (add)
3 Subtract nonhousing expenses fromtotal of Step 2
| $ |
|STEP 4: ESTIMATE MONTHLY HOUSING EXPENSES |
Proposed mortgage payment
Allowance for property taxes
Allowance for utilities (heat, water,phone, electricity)
Allowance for maintenance, furnishings
Allowance for insurance
4 Total monthly housing expenses (add)
| $ |
|STEP 5: COMPARE |
Compare estimated monthly housing expenses (Step 4) with income available(Step 3). If income available from Step 3 does not equal or exceed monthlyhousing expenses, then you must re-evaluate your budget and resources.
Total from Step 3 = Total from Step 4
FOR MORE INFORMATION, CONTACT:
MORTGAGE INSURANCE COMPANIES OF AMERICA
1425 K Street N.W., Suite 210
Washington, D.C. 20005
DEPARTMENT OF VETERANS AFFAIRS
for eligible veterans
FEDERAL HOUSING ADMINISTRATION
451 7th Street S.W.
Washington, D.C. 20410
USDA RURAL HOUSING SERVICE
Contact your local/county office listed in the government pages of your telephone book.
This brochure was developed by the Mortgage Insurance Companies of Americain cooperation with the Extension Service of the U.S. Department of Agriculture.
This publication may be reproduced in whole or in part by educational and nonprofit groups.
MORTGAGE INSURANCE COMPANIES OF AMERICA
1425 K Street N.W., Suite 210
Washington, D.C. 20005