Mortgages you can afford
Putting down 20% may be a thing of the past, but beware of the risks
NEW YORK (CNNfn) - If you've always thought owning your own home was far beyond your reach, think again.
A strong economy and competitive housing market are making home ownership a reality for a wide range of consumers, including those whose credit is damaged and those who can't come up with the conventional 20-percent down payment.
This may come as a surprise to some people, many of whom have never considered home ownership a viable goal.
"A lot of people self-select out of the market," said Steve O'Connor, senior director of residential finance at the Mortgage Bankers Association of America. "Even though they have the financial wherewithall to buy a home."
Many consumers who discount home ownership are burdened more by psychological restraints than financial ones. Perhaps their parents or other family members never owned a home or lending requirements in their native countries made home-buying a virtual impossibility.
"People have no clue there are 100-percent or 97-percent down mortgages they can qualify for," said George Fox, founder of the National Association of Mortgage Planners. "What the buying public needs to do is sit down, put a financial plan together and see what products are available out there."
Lower payments through insurance
The vast majority of low down-payment mortgages are made possible by mortgage insurance. This coverage protects the lender against financial loss if the homeowner stops making mortgage payments.
Most lenders offering low down-payment mortgages require mortgage insurance, which is underwritten both privately and by the government, each with its own restrictions.
Private mortgage insurance almost always requires a down payment of at least 5 percent, although a gift or grant from an outside sources such as a community group or family member can lower the requirement to 2 to 3 percent. There is generally a more generous limit on the loan amount, with loans as high as $240,000 acceptable. Freddie Mac and Fannie Mae offer these types of mortgages.
Government-backed mortgage insurance, sponsored by the Federal Housing Administration, Department of Veterans Affairs or Farmers Home Administration, often has down-payment minimums below 5 percent, but they may be stricter about the total loan amount. For instance, the FHA program, which is open to everyone, has a standard loan limit of $67,500 to $151,725 for a single-family home.
Piggybank loans are another option for those without the means for a conventional 20-percent down payment. With these loans, you are effectively taking out two mortgages.
For instance, you may take out a 80-10-10 loan, in which the borrower puts down 10 percent of the total cost, takes out a first mortgage for 80 percent under a market-competitive rate followed by a second mortgage for 10 percent at a higher rate.
When the two rates are blended, this type of loan can be a good deal.
"You're not financing the mortgage insurance and you build equity faster," said Fox.
Piggyback loans usually require at least 5 percent down, with a first mortgage of 80 percent and a second for 15 percent, but the 80-10-10 combination is much more common.
It is generally a good idea to meet with several lenders to determine which type of loan best fits your needs.
Despite their obvious perks, low down payments are not risk-free, nor are they a sure thing.
As with any loan, you will have to prove sufficient income to support the monthly payment, provide enough cash for the down payment and closing costs, and demonstrate a good credit background. In some cases, you may have to indicate a cash reserve equivalent to two mortgage payments.
"There has been an increased emphasis in recent years on good credit background," said O'Connor. "If you don't have an extremely good record, you will pay for it."
Most lenders divide loan applicants into "niches," which determine their eligibility. The higher risk category you fall into, the higher the required down payment or interest charges are likely to be.
Because of the inherent risks involved in taking out mortgage insurance, it is crucial that home buyers taking advantage of this approach don't take on too much house. While the insurance company will pay out the lender's claim on a defaulted loan, homeowners will lose their property through foreclosure.
Mortgage insurance also isn't necessarily cheap. The average private mortgage insurance payment, also known as PMI, is around $20 to $100 a month. The good news is the charge can be eliminated once the borrower reaches the 20-percent threshold.
How much is too much?
Given the array of low down-payment mortgages available, you may wonder if you might be better off putting down less and investing the difference elsewhere, in stocks for instance.
That depends, says O'Connor, who acknowledges there are two schools of though on the issue.
"Some people say you should pay down as much debt as possible," said O'Connor. "But you might make more by investing the money."
That, of course, depends greatly on the stock market or whichever alternative investment vehicle you are considering. While stocks and mutual funds have seen phenomenal gains in recent years, such performance is no guarantee. You'll also be missing out on a potentially large tax break, since mortgage interest payments are deductible.
"Clearly, you have to have the discipline to invest the money and not spend it," O'Connor said. "That's the most compelling factor."