Special to The Washington Post.
Special to The Washington Post.
WASHINGTON — Mortgage down payments as low as 3 percent — and even 100 percent loans — are returning. That may be good news for buyers who haven't accumulated a lot of savings.
But there are some trade-offs: Mortgage payments will be higher because more money is being borrowed and because private mortgage insurance is required for down payments that are less than 20 percent. With that in mind, buyers may want to consider renting for a longer time and saving more for a larger down payment to make sure they can truly afford a home.
If after careful consideration buyers settle on a low down payment, it's best to go in with eyes wide open. It's important to know the details of the loan program and the ramifications they may have on finances. The interest rate on a loan with 5 percent down will typically be slightly higher (one-eighth to one-quarter of a percent) than one with 10 percent or 20 percent down because the loan-to-value ratio is higher.
Before the housing bubble burst, many lenders offered borrowers 100 percent financing. Some lenders even allowed buyers to finance 105 percent of the home value.
Those zero down and low-down-payment loans were part of the problem that led to the housing crisis, because homeowners who never made a down payment found themselves quickly underwater when home prices dropped and were more likely to face foreclosure because they couldn't refinance without any home equity.
Conventional lenders quickly dropped risky loan products and the pendulum swung the other way to loans requiring a minimum down payment of 20 percent or, for borrowers with excellent credit, 10 percent. First-time buyers and repeat buyers who could not make a large down payment have been limited in recent years to loans insured by the Federal Housing Administration (FHA), which require both upfront and annual mortgage insurance premiums that increase monthly payments. Members of the military and veterans continuously have had access to zero-down-payment mortgages through the Department of Veterans Affairs loan program.
But now conventional lenders are bringing back mortgage loans with lower down payment requirements. Data from the Federal Housing Finance Agency shows that more people are putting less down when they purchase a home. In its recent report on conventional mortgages, the agency found that the share of loans for 90 percent or more of the price had grown to 23 percent in June from 15 percent a year before, while the share of loans for 70 percent or less of the price had declined to 23 percent from 26 percent.
"Most conventional loans require a down payment of 5 percent, but some programs allow a down payment as low as 3 percent," says Doug Benner, a loan officer with Embrace Home Loans in Rockville, Md. "A few banks and credit unions have special 100 percent financing products, too, that they keep as portfolio loans."
Portfolio loans are mortgages that financial institutions keep on their books rather than sell on the secondary market. Lenders can establish their own criteria and be more flexible than they are with loans that are being sold to Fannie Mae or Freddie Mac.
Traditional conventional loans that are sold to Fannie Mae or Freddie Mac require private mortgage insurance (PMI) for mortgages with a down payment of less than 20 percent, but borrowers have several options for paying PMI. They can pay it monthly until their loan-to-value ratio reaches 78 percent, or they can take advantage of other programs offered by many lenders, such as paying a one-time fee or having their lender pay PMI while they pay a slightly higher interest rate.
The resurgence of low-down-payment financing may seem dangerous on the surface, but Benner says the loans are different this time.
"When we saw these loans before the housing bubble burst, underwriting had gone out the window," he said. "Now everyone has to undergo detailed underwriting and provide complete documentation about their employment history, their income, their assets and their ability to repay the loan. It used to take just a rubber stamp to get a mortgage approved, but now every aspect of every loan is scrutinized."
At Navy Federal Credit Union, the 100 percent financing "Homeowner's Choice" loan program has been offered continuously except for a hiatus in 2008 during the height of the recession, said Katie Miller, vice president of mortgage products for Navy Federal Credit Union in Vienna, Va.
"The performance of these loans has been better than the performance of prime loan portfolios of other lenders," she said. "We service all of these loans in-house so we can get ahead of any issues and work with our members to resolve them."
The Homeowner's Choice loan program is a 30-year fixed-rate loan reserved for owner-occupied homes. The program is geared to first-time buyers and to members of the military who have their VA loan eligibility tied up in another property, Miller said.
Richard Morris, vice president of mortgage pricing for Navy Federal, said the company carefully reviews applicants' credit scores, debt-to-income ratios, job stability and use of credit. No specific minimum credit score is required because these loans are manually underwritten and member qualifications are reviewed on an individual basis.
"We charge five-eighths to seven-eighths more on the interest rate for a zero-percent-down-payment loan compared to a loan with a 20 percent down payment," Morris said. "The borrowers don't have to pay any mortgage insurance, though, which they do with an FHA loan or another conventional loan with less than 20 percent down."
TD Bank's "Right Step" mortgage program requires a minimum down payment of 5 percent, but unlike standard conventional loans, 2 percent of the down payment can come from sources besides the borrower, such as gifts or special financing from employers or government sources. This loan program doesn't require private mortgage insurance.
"The biggest obstacle to homeownership for most people is the down payment," said Malcolm Hollensteiner, director of retail lending sales and products with TD Bank in Vienna. "We require the borrowers to put in as little as 3 percent of their own funds into the home purchase."
TD Bank has rigorous requirements for this loan program, including a minimum credit score of 660 and strict debt-to-income ratios, Hollensteiner said.
"We utilize the traditional formula for debt-to-income ratios, so borrowers can use only a maximum of 33 percent of their income for their housing payment and up to 38 percent overall debt to income," he said.
Hollensteiner said the requirement that borrowers use at least some of their own money for the down payment, the strict debt-to-income ratios and the requirement that all borrowers go through homeownership counseling sets this loan program apart from mortgages that were commonly offered five or six years ago.
"Most people make a down payment of at least 10 or 20 percent if they have the money, but some people want to hold onto more of their assets," Benner said. "The important thing is to make sure you can afford the payments and have the cash to maintain [the house], too. If the mortgage payments are affordable with a 5 percent down payment, some people would rather save their cash."
Bill Moran, a financial adviser with Merrill Lynch in Washington, said deciding how much cash to use for a down payment should be based on the borrower's financial plan.
"Your down payment depends on so many variables," he said. "You need to get into the right mortgage, but if you're a young first-time buyer, you may also need to take into consideration your student loan debt and maybe some credit card debt. Instead of jumping in to buy a house, you need to look at all your financial goals and objectives; run through some scenarios and then decide if you should get into a house now or wait until you can accumulate more cash."
Moran said it's important for borrowers to look at their worst-case scenario, such as losing their job and being laid off for six months or a year, to see how they would handle that financially. Moran recommends having six to 12 months of expenses in cash reserves, so for some potential home buyers, a low- or zero-down-payment loan would be a good option to keep more cash in the bank.
"A lower down payment allows first-time buyers to make homeownership a reality," Hollensteiner said, "but on the other hand, with a higher down payment you have more equity right away and your monthly payments are lower. Every borrower is different, so each person needs to decide what's most important to them."
Tara Kirrane, a wealth-management banker with Merrill Lynch in Washington, said prospective buyers must understand their long- and short-term goals before deciding how much cash to put down on a home.
"You need to think about how long you'll stay in the home, what your job situation is, what you expect your income to be like in the coming years and your current cash flow," she said. "Before you can decide, you need to estimate what funds you have available for a down payment and then look at the monthly payments for different down payment options to make sure our pick the right loan option."