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This page was taken from a US government source, the url for which is no longer with me. If I ever discover the url, I will gladly add it.
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 insurance.
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
________________________________________________
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 insured.
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 first
house.
WHAT MAKES LOW DOWN PAYMENT LOANS POSSIBLE?
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 policy.
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 down payments.
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
mortgage insurers.
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 situation.
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 payment
* 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 Afford?
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
$700.
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 on.
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 homeownership.
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 debts.
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 should bring:
- A purchase contract for the house (if you have one)
- Your bank account numbers and the address of your bank branch,
along with checking and savings account statements for the
previous 2-3 months
- 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- employed
- 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 repaid.
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 Loan
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 homeowners.
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.
PAYMENT TABLE
MONTHLY PAYMENT FOR EACH $1,000 BORROWED
INTEREST RATE 15 YEARS 20 YEARS 30 YEARS
4.00% $7.40 $6.06 $4.77
4.50% $7.65 $6.33 $5.07
5.00% $7.91 $6.60 $5.37
5.50% $8.17 $6.88 $5.68
6.00% $8.44 $7.16 $6.00
6.50% $8.71 $7.46 $6.32
7.00% $8.99 $7.75 $6.65
7.50% $9.27 $8.06 $6.99
8.00% $9.56 $8.36 $7.34
8.50% $9.85 $8.68 $7.69
9.00% $10.14 $9.00 $8.05
9.50% $10.44 $9.32 $8.41
10.00% $10.75 $9.65 $8.78
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.
Worksheet: Evaluating Your Financial Resources
STEP 1: DETERMINE NET MONTHLY INCOME
Gross Monthly Income
Gross base pay (All wages and salaries other than overtime)
Net profit (from business)
Interest and dividends
Other income
Total gross income (add) =
Deductions
Income tax (federal, state and local)
Social Security/retirement
Insurance (life, health, property)
Other (charities, etc.)
Total Deductions (add) =
1. Total take-home pay
Subtract deductions from income =
STEP 2: FIGURE LONG-TERM MONTHLY OBLIGATIONS
(in excess of 11 months)
Installment payments on car or furniture
Other debt, over 11 months
Total long-term debt (add) =
2. Subtract long-term debt from total take-home pay.
Bring forward the number from Step 1 =
STEP 3: MONTHLY NON-HOUSING EXPENSES
Food, beverages (home and work)
Transportation/auto expenses
Education
Medical/dental care
Clothing and grooming
Insurance (life and health)
Child care
Gifts and charity
Entertainment and recreation
Savings
Other
Total monthly non-housing expenses (add) =
3. Subtract non-housing expensis from tatal of Step 2 =
STEP 4: ESTIMATE MONTHLY HOUSING EXPENSES
Proposed mortgage payment
Allowance for property taxes
Allowance for utilities (heat, water, phone, electricity)
Allowance for maintenance, furnishings
Allowance for insurance
4. Total monthly housing expenses (add) =
STEP 5: COMPARE
Compare estimated monthly housing expenses (Step 4) with income
available (Step 3). If income available from Step 3 does not equal or
exceed monthly housing expenses, then you must re- evaluate your budget
and resources.
Total from Step 3 > OR = Total from Step 4
*This worksheet was reprinted with permission from the Small Homes
Council - Building Research Council, University of Illinois at Urbana.
For further information, contact:
Department of Veterans Affairs
1-800-827-1000
- for eligible Veterans
Office of Insured Single Family Housing
Programs & Procedures Branch
451 7th Street, S.W., Room 9276
Washington, DC 20410
202-708-2676
- for FHA information
Farmers Home Administration
- contact your local/county office listed in the government pages
of your telephone book.
This brochure was developed by Mortgage Insurance Companies of America
(MICA) in cooperation with the Extension Service of the U.S. Department
of Agriculture (USDA).
This publication may be reproduced in whole or part by educational and
non-profit groups.
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