Options For Paying A Reduced Down Payment

How to Pay a Reduced Down Payment When Buying a HomeA huge part of the difficulty in realizing the possibility of buying a home is coming up with the requisite down payment. Did you know there are actually more than 2,400 programs nationally that can help?  Finding them, determining which ones are applicable to you, and then understanding these programs parameters can be a challenge. This article is intended to discuss the major programs; share some insight into the lesser known programs; suggest sources to find highly specific programs you might be eligible for, and to give you the core elements into the most crucial things to look for and why. 

Why Down Payments Are Important

First it is important to understand why down payments are important. In the proverbial nutshell, down payments are your mortgage lender’s padding against an upside-down situation should a buyer default on their mortgage payments.

By requiring a buyer to put some equity (cash investment) into their home of choice at the start is akin to the buyer putting some skin in the game so they’re more ready to face the costs of homeownership. It is more than merely a safe guard for lenders; it is the tangible manifestation of a buyer’s honest intent to purchase and maintain the home for at least a while before listing it on the market for resale. It is sort of the “put your money where your mouth is” philosophy.

The buyer’s benefits of a down payment:

  • You build instant equity in your home – before making a single mortgage payment.
  • Your monthly mortgage cost is reduced as the loan you take out is for the value of the home as agreed to by the buyer and seller less the amount of your down payment. In other words, if you put in an offer on home worth $250,000 and you can put a 20% down payment of $25,000 – your mortgage would be $225,000 rather than the full sale price. Because you are financing less money the cost of your monthly mortgage payment is lower.
  • No MIP (Mortgage Insurance Payment) required when making a 20% down payment.

Who Offers Programs That Can Assist With Down Payments?

Our concentration will be on the first three; you need to check with your employer to see if down payment assistance is part of the benefits package.

  • State Housing Finance Agencies (HFA) often offer the broadest array of opportunities.
  • Cities and Counties offer programs with criteria adjusted for local median income and home prices.
  • Housing Authorities.
  • Non-profits.
  • Employers (check if your place of employment offers help)

General Overall Rules and Regs for Programs Offering Assistance

  1. Homeownership programs are for owner-occupant buyers only; not investment properties. 
  2. Both you and the home you are purchasing must be eligible for qualification in any particular program. 
  3. You must make a minimum investment, qualify for a first mortgage and complete homebuyer education. Common eligibility factors include the home’s sales price, homebuyer income and homeownership history.
  4. A first-time homebuyer is defined as someone who hasn’t owned a home in 3 years. So, if you’ve owned in the past but are renting now, you can qualify as a first-time home buyer.
  5. There are often additional benefits, or even entirely separate programs, for educators, public protectors (police, firemen, etc.), health care workers, veterans, and households with disabled members. Be sure to check available programs through your job and support groups.

The 3 Primary Sources for Financing Loans With Low Down Payments

There are three primary loan programs for help with obtaining a low down payment loan. Two of these you probably have heard of; the 3rd is often misunderstood.

FHA Loans

FHA Loan is a mortgage that is insured by the Federal Housing Administration. The federal government insures loans for FHA-approved lenders in order to reduce their risk of loss if a borrower defaults on their mortgage payments.

FHA Loan Requirements

The key element to remember when considering an FHA loan is that the lower an applicant’s credit score – the higher the down payment percentage required. That noted, there are a number of other requirements that must be met in order to qualify.

  • New FHA loans are only available for primary residence occupancy.
  • Borrowers must have a minimum credit score of 580 for maximum financing with a minimum down payment of 3.5 percent.
    • If a borrower’s credit score is lower (500-579) a 10% down payment is possible if all other criteria is met.
  • FHA borrowers must pay mortgage insurance premiums (MIP) as a protection for the lender if a borrower defaults. Because FHA loan do not have the strict standards of a conventional loan, they require two kinds of mortgage insurance premiums: one is paid in full upfront or financed into the mortgage and the other is a monthly payment.
    • Upfront mortgage insurance premium (UFMIP): This is a one-time upfront monthly premium payment, which means borrowers will pay a premium of 1.75% of the home loan, regardless of their credit score. 
    • Annual MIP (Annual MIP) is an annual premium that is charged incrementally over a twelve month period and is factored into your mortgage payment. The amount of the mortgage insurance premium is a percentage of the loan amount, based on the borrower’s loan-to-value (LTV) ratio, loan size, and length of loan.
    • Duration of FHA mortgage insurance payments assigned on or after June 3, 2013 - borrowers will have to pay mortgage insurance for the entire loan term if the LTV is greater than 90% at the time the loan was originated. If your LTV was 90% or less, the borrower will pay mortgage insurance for the mortgage term or for 11 years - whichever occurs first.
  • Borrowers must have proof of a steady employment history. 
  • Borrowers must have a valid Social Security number, lawful residency in the U.S. and be of legal age to sign a mortgage in your state.
  • Borrowers must pay a minimum down payment of 3.5 percent. 
  • Borrowers’ front-end ratio (mortgage payment plus HOA {Home Owners Association} fees, property taxes, mortgage insurance, homeowners insurance) needs to be less than 31% of their gross income as a general rule to guarantee they're buying a home within their means.
  • Borrowers’ back-end ratio (mortgage plus all your monthly debt, i.e., credit card payment, car payment, student loans, etc.) needs to be less than 43% of their gross income as a rule.
  • Borrowers must have a property appraisal from a FHA-approved appraiser and the property must meet certain minimum standards at appraisal. 

Benefits of FHA Loans

  • Low Down Payment 
  • Less Stringent Credit Score Requirements
  • FHA loans are an assumable mortgage. This means if you want to sell your home, the buyer can “assume” the loan you have, pending credit approval and lender processes. 

VA Loans

Available only to past service members, VA loans are a huge benefit. Often they don’t require a down payment. Zero. None. This is because the federal guaranty takes the place of the down payment. Since a portion of the loan is backed by the government, there’s no need for an additional down payment.

As long as lenders follow VA guidelines, a part of every VA loan is guarded by a federal safety net. If a service member defaults on a loan, the federal government agrees to pay the lender back for at least a portion of the loss. This backing is the “VA Loan Guaranty.” 

Another huge plus for VA loans is that buyers (you) are not charged mortgage insurance. In combination these two benefits can save homebuyers a bundle of money. 

Benefits of VA Loans

  • No down payment.
  • No mortgage insurance.
  • They’re reusable. You can use your full VA entitlement over and over again as long as you pay off the loan each time.
  • There is no pre-penalty payment should you be able to pay off your mortgage early.
  • They’re available despite foreclosure or bankruptcy. Service members with a history of bankruptcy or foreclosure can secure a VA loan. Even borrowers who have had a VA loan foreclosed on can still utilize their VA loan benefit.

Restrictions on VA Loans

  • VA loans are for primary residences only.
  • VA loans are designed for ‘move-in ready” homes – single-family homes, condos, modular housing, some multi-unit properties, etc.
  • VA loans carry a mandatory fee called the VA Funding Fee. This fee (usually 2% of the loan amount) helps the VA keep the program going and is required on both purchase and refinance loans. The fee can be rolled into the loan amount and waived entirely for those with service-connected disabilities.

It is no wonder that military buyers love their access to VA loans and the exclusive financing program. It should be noted that the VA loan guaranty has cash limits which vary based on location. For a look at the limit for your area, check with the Department of Veterans Affairs.

USDA Loans

The USDA loan program is the one least known and least understood. It is a zero-down, 100% financing home loan sponsored by the United States Department of Agriculture designed to promote homeownership in less-dense communities. it does not mean you need to be a farmer! Nor do you have to live in the boon-docks.

In reality a full 97% of the U.S. land mass falls into eligible status for USDA financing and is available to about 1/3 of the entire population. Check your USDA loan eligibility.

The application process for a USDA loan is similar to that of a FHA loan. 

  1. Find a lender that offers USDA financing at this link. Most lenders in the U.S. can approve USDA home loans.
  2. Obtain lender preapproval. 
  3. Find a house: Use your preapproval letter to make an offer on a USDA-eligible home. 
  4. Obtain lender approval for your mortgage. 
  5. The lender submits your full loan file to USDA for approval.
  6. Close on loan: You sign final paperwork and within a few days the house is yours.

Major Benefits of USDA Loans

  • The only civilian zero-down loan on the market.
  • Lower down payment than conventional or FHA financing.
  • Lower mortgage insurance than conventional or FHA loans.
  • More lenient credit score requirements than for conventional loans.
  • Unlike VA loans, there is no military service requirement.

Eligibility Requirements for a USDA Home Loan

There are two main factors for USDA home loan eligibility - the property and the home buyer.

Property Requirements:

  • USDA property eligibility - The home must be located within a USDA-eligible area. 

Generally, cities and towns with a population less than 20,000 qualify, but bigger cities are eligible if they are “rural in character” or don’t have good access to mortgage credit.

Property eligibility maps haven’t been fully updated in over 15 years. This means many surprisingly populous areas across the U.S. qualify

  • Pass required safety standards, etc.

Buyer Requirements:

  • Owner occupant; single-family home, apartment, townhouse, or condo.
  • Lender will verify USDA rural development loan eligibility in the same way as for any other home loan program. Your credit, income, and bank account information will be compared to current guidelines for USDA loans.
  • You do not need to be a first-time home buyer.
  • USDA income limits require an income of 115% or less of your region’s median income.
  • The applicant’s income determines the maximum loan size. 
  • Asset limits - If you have 20% down, you may not use USDA financing. According to USDA guidelines, this loan is reserved for those who can't qualify for other mortgage types, such as conventional loans.
  • Dependable employment for 2 years.
  • USDA loan debt-to-income ratio (DTI): 29% of your pre-tax income can go toward the principal, interest, taxes, insurance, and HOA dues on the home you plan to buy. A total of 41% of your income can be used for your proposed house payment plus all other debt. 
  • You must be a U.S. citizen or have permanent resident status, be a non-citizen national or qualified alien to qualify for the USDA program. Valid evidence of residency status is required.

USDA offers Direct Loans and Guaranteed Loans

  • Guaranteed loans are offered by private lenders and backed by USDA. 
  • Direct loans have more stringent requirements, such as very low income limits. USDA offices issue these loans directly to consumers.
  • Available in 30-year and 15-year fixed rate mortgage options. Because fixed rates are the most time-tested and safe for home buyers, USDA does not offer adjustable-rate loans.
  • You can use USDA to refinance if you have a USDA mortgage currently. Read more about USDA refinancing here.
  • Check here for eligibility.

In Conclusion

We’ve only covered the three major loan programs in this article. As noted at the start, there are a number of other sources to assist with putting together a down payment. Grants, gifts, and loans are a few. Some are need-based; others area of work; still others are focused on volunteer work.  Investigate all your possible avenues.

Take a solid, hard look at your financial situation to understand if a lower down payment is right for you and if you’re ready to buy a home. Understand that finding an avenue offering low payments can mean more stringent terms, greater risk, more monthly payments, etc. Yes, finding a lower down payment can be tempting; to do so is a decision that cannot be taken lightly nor on surface value only. 

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