Pros and Cons of Super Low-Down Payment Mortgages
Programs that help first-time buyers put down less than 10 percent of the purchase price have been around for many years. FHA, VA, and state and local housing programs are three of the best-known sources of loans ranging from 3.5 to 5 percent down. In recent years, some commercial lenders have offered mortgages as low as 3 percent down, and in 2017, a number of banks, credit unions, and mortgage companies introduced mortgages requiring as little as 1 percent−or even zero percent−down.
These super low-down payment programs raised fears that would generate riskier loans and possibly return the real estate economy to the days of “pulse loans” that were a big factor in the collapse of housing markets in 2007 and caused 3 to 5 million families to lose their homes. Most experts believe that is highly unlikely because of the regulators and higher lending standards imposed by lenders. In fact, defaults among current low down payment mortgages of 5 to 10 percent down remain low and performance has been much better than among similar loans in 2005-2006.
The new super-low down loans are really 3 percent loans that lenders make possible by giving borrowers the difference in the down payment. Many of these lenders were recouping their gifts by charging high-interest rates or origination fees. This practice, known as “premium pricing” was outlawed by Freddie Mac in August 2017, and Fannie Mae never allowed it.
However, some lenders, notably Quicken and Navy Federal Credit Union, do not practice premium pricing and they still offer loans at 1 percent down.
There are good reasons for getting one of these loans and good reasons not to. Much of the decision depends on your qualifications and expectations. Here’s a list of the pros and cons.
Pros of Super-Low Down Loans
- It’s a fast way to homeownership. Low down payment loans are a popular tool for first-hand buyers who don’t want to wait months or even years to save 20 percent for a for a down payment. By buying a house now, they avoid higher interest rates in the future and benefit from rising home values. Super-low down payment loans makes it easier to buy a home.
- Avoid rising rents. Rising rents are making it even harder to save for a down payment. A super-low down payment gets you out of the “rent trap” and puts you on the road to get something back from your housing dollars − equity.
- Makes hot markets more affordable. Buyers on hotter markets where prices are rising fastest are seeing the cost of a down payment soaring. A super-low down mortgage might be the only way they can buy a home where they are living.
Cons of Super-Low Down Loans
- It’s tougher to qualify. Lenders protect themselves from default on low-down loans where buyers have little “skin in the game” so credit scores and debt ratios are tougher than they are for loans with larger down payments.
- Watch out for “premium pricing.” Lenders who offer loans for less than 3 percent down payments should not try to recoup the amount they offer to lower your down payment by charging higher fees or setting higher interest rates.
- The lower the down payment, the longer it takes to build equity. Low down payments make it harder to build equity. Equity is the difference between the value of your home and the amount you owe on your mortgage. If you actually pay the appraised value of your new home-which is unlikely when prices are rising quickly—you begin with zero equity. Mortgages are structured so that you pay more interest in the first years of the loan, and less in the later years. The less you put down, the longer it will take to build equity.
- Low down loans pose a risk. If home values decline, as they did in most markets between 2007 and 2013, you will have more “negative equity” if you made a smaller down payment. Should you lose your job and cannot pay your mortgage every month, you will be unable to sell your house, and you will default.
If you have doubts about taking out a loan with a super-low down payment, you might want to get a 3 percent loan from Freddie Mac or Fannie Mae’s first-time buyers’ programs, FHA, or a state or local housing finance agency where you can find a down payment resource. After all, the difference between a 1 percent down payment and a 3 percent down payment on a $250,000 home is only $5,000. If you’re a qualified veteran, you don’t have to worry about down payments at all, because VA loans don’t require a down payment.