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.
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. |
