3 percent down payments are
back, but are they a good idea?
Do you have decent credit, a good job, and want to buy a home, but don’t have enough money for a 10 or even 5 percent down payment? Well, there may be some hope.
Recently, Freddie Mac and Fannie Mae announced that they would start backing mortgages with down payments as low as 3 percent.
This change could help a lot of people get homes, or save money on refinancing FHA mortgages. To see if this new option could help you, and what the benefits and drawbacks are, read on.
Why 3 Percent Down Payment Mortgages Are Coming Back
“[Conventional loan lenders] offered 3 percent down loans in the past, but then with the housing crisis, and houses decreasing in value, it became too risky for [Freddie Mac and Fannie Mae] to back those loans, so they backed it down to a minimum of 5 percent down,” says Jim Duffy, branch manager for Atlantic Bank Mortgage Group of Charleston in North Carolina.
So, if 3 percent down loans were so risky, why in the world would lenders want to bring these loans back?
“I was a little surprised by the announcement myself,” says Duffy. “However, most housing markets across the country are stabilizing very well and growing with appreciation. So I think they see that the risk is not as high to lose money and the need is there.”
He says the need comes in the form of many buyers having good jobs and income, but because of the financial crisis, perhaps not a lot of money saved. So their credit is good, they have a good job, but they can only put 3 percent down.
Currently, these borrowers turn to Federal Housing Association (FHA) mortgages, but Duffy says FHA loans come with downsides, like a requirement to carry expensive insurance premiums for the life of the loan. As such, getting a conventional loan with 3 percent down would be a welcomed alternative.
Conventional 3 Percent Down vs. FHA 3.5 Percent Down
The FHA has been offering homebuyers 3.5 percent down payment mortgages for a long time, but there are some significant differences when compared to the conventional 3 percent down.
One difference is in the mortgage insurance rates that each loan carries. Each loan requires mortgage insurance, which lenders require when the buyer puts less than 20 percent down.
But the insurance can vary greatly, says Duffy. In fact, he says, since 2008 the mortgage insurance that is required with FHA loans has become more and more expensive and is now at an all-time high.
“The insurance premium for FHA mortgages is 1.75 percent up front, which normally gets added to the loan balance, and 1.55 per year,” says Duffy. So, to make that clear, on a $100,000 mortgage, you would pay $1,750 at the time you take out the mortgage and $1,550 per year ($129 per month) every year thereafter. On a $200,000 mortgage, double that.
And while he says that there is no simple formula for the insurance rate on a conventional 3 percent down mortgage, it will almost always be less expensive than the FHA loan.
“It’s hard to estimate insurance premiums for conventional loans because it comes from private mortgage companies (PMI) and they all have tiered pricing based on loan to value, sometimes geography, and definitely the borrower’s credit score,” says Duffy.
But, he continues, the annual rate will almost always be less, and more importantly, there is no up-front cost. That’s a huge advantage, he says, because for every $100,000 borrowed, that’s $1,750 less you have to pay or borrow.
Finally, he says, there is one last important advantage. “The third positive is that, although it will take several years to get there, the insurance premium on the conventional mortgage [PMI] will eventually go away. Once you get to 78 percent loan-to-property value, it falls off,” says Duffy.
But as for FHA loan, the new rules dictate you pay it for the life of the loan. “To get rid of it you need to sell or refinance,” says Duffy.
Who is the New 3 Percent Down Conventional Mortgage For?
It’s true that these mortgages are not for everyone. For instance, if you can put 5 or 10 percent down on your home, you should, says Duffy. In most instances, the less money you put down, the higher your interest rate will be.
It won’t be a lot, an eighth or quarter percent, but, when it comes to hundreds of thousands of dollars, small percentages can make a big difference.
For those who can’t afford higher down payments, the 3 percent down mortgage does fill an important need, says Duffy.
“For would-be homebuyers who don’t have a lot of wealth accumulated or cash to put down, but do have good credit and a good income, the only option has been FHA. But, as pointed out, FHA has raised their insurance premiums considerably and at the same time they’ve made the mortgage insurance permanent. So this will be a great option,” says Duffy.
You will need certain things to qualify, however. “It’s really limited to buyers with good credit and a lot of job stability, with a good debt-to-income ratio,” says Duffy.
What Should You Consider When Putting Just 3 Percent Down?
All good things come with a downside, and 3 percent down mortgages are no exception. There are a few things to consider.
For one, with only 3 percent down, you are closer to losing your equity if the value of your home decreases, says Duffy.
“There’s been some talk that, if interest rates spike, it would put so much pressure on the home market that values would come down. If that were to happen, yes, if you have only 3 percent equity, you are closer to getting ‘underwater.’ And it’s certainly something to consider,” says Duffy.
Another consideration is that if you’re putting only 3 percent down, it likely means that you’re doing it because you don’t have a lot of cash reserves, says Duffy. So, you should take precautions for that.
“My council would be not to max out your debt-to-income ratio because there will probably be other expenses on a new home you’re not aware of. So you’ll want to know you have some extra cash in the budget for any surprises,” he says.
Whatever you decide, just be sure to keep this in mind: If there’s one thing that a return to 3 percent down payment mortgages has taught us, it’s that life is full of surprises.