How to Choose the Low-Down-Payment Mortgage That’s Right For You

Coming up with 20% down isn't always necessary. Here's what you need to know about lown-down-payment mortgage programs.

Low down-payment mortgage loans have been around much longer than most people realize. The Federal Housing Administration  loan requiring just 3.5% down re-emerged in 2008, but today, loans backed by the government requiring even less down are becoming popular. Here are the different kinds of low-down-payment loans available and what you should know about each.

1. FHA Loans

These are loans insured by the Federal Housing Administration that require just a 3.5% down payment and are incredibly flexible on financial history, credit history, and debt-to-income ratios. It is the most widely known low-down-payment program available in the market, is incredibly popular, and is virtually limitless in terms of the property type, income and location. Learn more about FHA loans here.

2. Conventional Loans

Some conventional loans require just 5% down, and in some cases as little as 3% down based on the per-capita-income in the area in which the property is located.

3. USDA Loans

This loan requires no down payment whatsoever and has income limitations and specific area locations. The program is only available in certain areas that are deemed agricultural by the U.S. department of agriculture.

4. VA

The U.S. Department of Veterans Affairs guarantees loans for up to 100% loan-to-value with absolutely no money down. This is hands down the best program in the low-down-payment arena. The program is available to U.S. military veterans and their spouses only.

5. Down Payment Assistance

Some state-specific programs allow homebuyers to put as little as $500 down to purchase a home. For example, in the state of California, a grant is provided for up to 5% of the loan amount, which can go toward the down payment and closing costs.

6. One-Percent Loans  

Some lenders are starting to offer mortgages for as little as 1% and, in some cases, even no money down with grants that need not be repaid. These loans are backed by Fannie Mae, and the lender bears the risk. You can bank on income limitations and needing good credit scores for such programs.

Keep in mind that the better the loan program you have, and the more down payment you have, the better your chances of getting into contract. Plus, most of the low down-payment loan programs available in the marketplace today, except for FHA and a traditional 5% down conventional loan, have income limitations. Income limitations mean your borrowing power in a certain geographic area is limited. Whereas, if you could use a 3.5%-down FHA loan or a 5%-down conventional, for example, your odds of getting into contract would be far greater because your borrowing power would be kicked up a couple of notches.

Here Is some homework to consider:

  • Do you have a down payment? If yes, where do those funds come from? Have you talked to your family about the possibility of getting gift funds for a down payment? You might be surprised by how generous your family could be.
  • If your down payment is very limited, get an honest answer from your real estate agent and lender about your ability to perform in this marketplace and what it would take to make you stronger on paper.
  • Get your financial house in order. That means checking your credit scores — you can see two for free on Credit.com. (the better your credit, the more home you can typically qualify for and the lower your interest rate will be), compiling your recent W-2s, pay stubs, and bank statements so you have enough information to provide to a lender.

Do not accept a lender giving you a just a pre-qualification letter. You want to be pre-approved. Any lender that will not give you a pre-approval letter is a lender that is more concerned about their policies than they are getting you into a home.

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The No-Down-Payment Loan Everyone Wants, But Few Get

buying a home

One mortgage loan program that’s become popular in recent years is the U.S. Department of Agriculture loan. The program allows you to buy a home with no money down and low monthly mortgage insurance. Here’s what you need to know if you’re interested in this type of financing.

What the Program Entails

The USDA offers this mortgage loan program to help less-industrialized areas attract more homeowners. The USDA determines certain areas in each county nationwide that allow borrowers to put no money down and purchase a home with a 30-year fixed-rate mortgage. As an example, Sonoma County, California has a few USDA-eligible areas. But loan applicants must not earn more than $97,000 per year.

Location Is Everything

The USDA will only grant loans to borrowers aiming to buy a single-family house for less than $375,000. So if you want to buy a house in Sonoma County, where median home prices exceed $375,000, you may find a USDA loan does not suit your needs.

Let’s rewind the clock to 2012 using our Sonoma County example. Back then, its median home price was $325,000, and as such, USDA loans were popular. That is, the USDA’s view on affordability was consistent with the local housing market. But in several markets nationwide, the average median home price per area has soared, exceeding $375,000 in many pockets. Simply put, in order to qualify for a house in the $425,000 to $450,000 range, you need to earn $97,000 a year or more, which would render you ineligible for the USDA loan.

This income-to-payment depiction is also based on cumulative debt. If you carry a car loan, student loan or credit card debt, for instance, you would need even more income, which would push you out of the USDA box. The USDA loan has a strong debt-to-income ratio requirement at 31%.

What’s Practical for Your Market 

It’s important to speak with a lender about how much house you can afford. You should also speak with a real estate agent to learn the average price for your area and what kind of homes fit your budget. To purchase a house in Sonoma County, California, for example, you’ll need at least $20,000 to get your foot in the door. And it will probably mean having to look at different types of mortgages, such as Federal Housing Administration loans, which would require a 3.5% down payment but offer a more flexible debt-to-income ratio requirement. Alternatively, a 5% down conventional loan may be more appropriate since, like an FHA loan, there are no limitations on location or household income.

Until the USDA adjusts its requirements, USDA loans generally will remain out of reach for prospective homebuyers. Of course, the biggest obstacle, aside from figuring out which mortgage loan program is best for you, is getting the house in contract. Many sellers consider a USDA loan offer from a client with 100% financing less attractive than a borrower with down payment funds. Knowing this fact alone may help you get an offer accepted than going with a loan that’s inconsistent with the local housing market.

Remember, you won’t get very far with any mortgage application if your credit’s not in good shape. To see where you stand — and how debt may be affecting your creditworthiness — you can view your free credit score, updated monthly, on Credit.com.

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