How to Buy a Home with a Low Down Payment
A Consumer's Guide to Getting Your Key in the
Door With as Little as Five Percent Down
OWNING A HOME: THE AMERICAN DREAM
If you're dreaming of buying a home,
congratulations. You're in good company! Almost two-thirds of the nation's households own
their own home.
This brochure describes how families can get
into their own homes with little cash up front. It explains mortgage insurance and how it
works, and looks at the two options -- private mortgage insurance and government mortgage
Why Buy a Home?
Homeownership remains one of the highest goals
for many people because of its many benefits. Along with owning your own home comes a
sense of security and belonging that cannot be found elsewhere. For many, homeownership
represents personal and financial success. There is much personal satisfaction in living
in a home that you own. A home is still a valued investment which can have many financial
advantages and tax benefits. The amount of interest you pay on a home loan and the real
estate taxes you 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 who own their homes are more involved in their local communities and
participate in local events.
The rewards of homeownership: - personal
satisfaction - sense of community - tax savings - stability for you and your family -
investment in the future - and more.
Obstacles to Homeownership
Still, for many Americans, owning a home
continues to remain just slightly out of reach. For more and more families, saving the
money for a down payment is the biggest obstacle to homeownership. Many people mistakenly
believe that you have to come up with a down payment equal to 20% of the price of a home.
Traditionally, lenders have required that home
buyers be able to make a down payment of at least 20% of a home's purchase price to get a
home loan or mortgage. However, mortgage lenders will grant home loans to qualifying home
buyers with a down payment of as little as 5% of the purchase price, if the mortgage is
In fact, home loans with down payments of less
than 20% are increasingly popular. They are called "low down payment mortgages."
This is good news for the millions of home
buyers who are finding it difficult to save a large down payment, especially for their
WHAT MAKES LOW DOWN PAYMENT LOANS
Simply put, mortgage insurance protects the
mortgage lender against financial loss if a homeowner stops making mortgage payments.
Lenders 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 lender'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 lender.
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
The Secondary Market
The lender'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
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 (GNMA). 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 the 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
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) or guaranteed by the Department of Veterans Affairs
(VA) or the Farmers Home Administration (FmHA).
The minimum down payment required by FHA is less
than 5%. For single-family homes, the standard limit for an FHA-insured mortgage ranges
from $67,500 to $151,725 (in certain high-cost areas).
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 lender 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
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, the lender or loan originator 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 or relative, or a 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 lender prefers to work with government or
conventional mortgages, your lender will discuss which one would be better for your
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 lenders 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 lender handles all of the arrangements.
By making lending money to home buyers safer,
mortgage insurance helps more families get into homes of their own.
QUALIFYING FOR A LOW DOWN PAYMENT LOAN
Qualifying for a low down payment loan
is much like applying for a regular loan.
To be considered for a low down payment loan,
you generally need to have:
- Sufficient income to support the monthly mortgage
- 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 lender will
give you a more exact estimate of your closing costs.
Points are finance charges that are calculated
by the lender at closing. Each point equals 1% of the loan amount. For example, 2 points
on a $100,000 loan equals $2,000. Lenders 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
There are two basic formulas commonly used by
lenders 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 from lender to lender 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
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
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
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.
What Kind Of Property Can You Buy With A
Low Down Payment Loan?
There are few restrictions regarding the type of
home you may buy with a low down payment loan. In addition, low down payment loans may be
used with the wide variety of mortgages.
Besides price range, there are many other
factors to consider when purchasing a home. It's in your best interest to take care in
selecting a home that will have lasting value as well as provide shelter. Be sure the
neighborhood and house meet the needs of your family. If you have children, you may want
to know if there are other children in the neighborhood and what schools or playgrounds
are nearby. Also consider the availability of public transportation and how far family
members will have to commute to work or school.
Check on the condition of the plumbing, heating
and electrical systems and whether they are up to code regulations. The best and easiest
way to do this is through a certified home inspection, from a certified inspector.
If you are like most people, a home is the
single largest purchase you will ever make. It is important that you select a home that
will meet your family's needs and keep you happy for years to come. And most important,
you must be 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 interview where the prospective home buyer and the lender meet to discuss the
potential loan. You will need to bring information to verify your income and long-term
Often people prefer to meet with the lender
before house hunting to determine in advance what price range they can realistically
afford and the mortgage amount for which they can qualify. This step is called
pre-qualification and can save you much time and trouble by making certain you are looking
in the correct price range.
For your first meeting with the lender, you
- A purchase contract for the house (if you have
- Your bank account numbers and the address of your
bank branch, along with checking and savings account statements for the previous 2-3
- Pay stubs, W2 withholding forms, tax returns for
two years, or other proof of employment and income verification
- Divorce settlement papers, if applicable
- Credit card bills for the past few billing
periods, or canceled checks for rent or utility bill payments, to show payment history and
amount of revolving debt
- Information on other consumer debt such as car
loans, furniture loans, student loans and retail/credit cards
- Balance sheets and tax returns, if you are self-
- Any gift letters, if you are using a gift from a
parent or relative or other organization to help pay the down payment and/or closing
costs. This letter simply states that the money is in fact a gift and will not have to be
Having these items on hand when you visit the
lender will help speed up the application process. Usually an application fee and the
appraisal fee will have to be paid when you submit the mortgage application. This is only
done after you have successfully negotiated on a home and have had your offer accepted by
the seller. Generally, there is no fee for pre- qualification.
After the initial meeting with the lender, you
should have a general idea if you qualify for the size and type of loan you want. The
lender should let you know if you qualify for the loan in 30 to 60 days. If you are denied
a home loan, the lender must explain the reasons. If this happens, the lender will usually
discuss any options with you.
Two Key Factors in Qualifying for a Home
In attempting to approve home buyers for the
type and amount of mortgage they want, lenders basically look at two key factors: the
borrower's ability and willingness to repay the loan. Ability to repay the mortgage is
verified by your current employment and total income. Generally speaking, lenders prefer
for you to have been employed at the same place for at least two years, or at least be in
the same line of work for a few years.
The borrower's willingness to repay is
determined by examining how the property will be used. For instance, will you be living
there or just renting it out? Willingness is also closely related to how you have
fulfilled previous financial commitments, thus the emphasis on the credit report or rent
and utility bills.
It is important to remember that there are no
rules carved in stone. Each applicant is handled on a case-by-case basis. So even if you
come up a little short in one area, perhaps one of your stronger points will make up for
the weak one. Everyone involved in real estate is in the business of selling homes, in one
way or another. Therefore, if the loan makes sense, lenders and insurers will do their
best to see that you qualify.
By its very nature, mortgage insurance is an aid
to affordability, because it allows families to purchase homes with less cash on hand. The
industry plays a central role in helping low- and moderate-income families become
More and more borrowers are taking advantage of
low down payment mortgages and becoming homeowners with as little as 5 percent down. For
more information on how you can take advantage of the benefits of a low down payment home
loan with mortgage insurance, contact your local lender 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
This table helps you calculate
your monthly housing costs, not including taxes and insurance. For example, assume you
have a 30- year mortgage and the interest rate is 8 percent. The chart shows that the
monthly payment amount per $1,000 is $7.34. If you want to borrow $75,000, you can
estimate the payment by multiplying 75 x $7.34, which equals $550.50 per month.
As you can see, the lower the interest rate, the
easier it is to afford a home.
This information was developed by
Mortgage Insurance Companies of America (MICA)
in cooperation with the Extension Service of the U.S. Department of Agriculture (USDA).