The lowdown on mortgages: Some require little upfront cash

4 min read

It is easier than ever to buy a house without having any cash on hand, thanks to new programs rolled out by an industry anxious to get as many people as possible into homes of their own.

Borrowers need as little as 3 percent up front to qualify for loans available through lenders nationwide, and they needn’t use their own money. The loans are backed by the big boys of mortgage financing — Fannie Mae and Freddie Mac.

Buy now, pay later

The programs are available from a broad range of lenders and can be beneficial for first-time home buyers, or those who have good credit but not a lot of savings.

What doesn’t cost borrowers now, however, often costs them later in higher monthly payments and other charges, because lenders see low-down payment borrowers as greater default risks.

“It is first and foremost an affordable product for those people who have very little down payment money on hand, and for those who have low or moderate incomes,” Freddie Mac spokesman Douglas Robinson says of the agency’s suite of programs.

“It’s what we do. We want to make people who can qualify, and who have the intention of becoming homeowners, get into homes if they can meet some set of guidelines.”

Federal guidelines apply

Fannie Mae and Freddie Mac design loan programs that spell out a set of standards for lenders. Those lenders, in turn, offer walk-in customers low down payment packages that conform with those standards. The two government-chartered agencies later buy those qualifying loans, bundle them into securities, and sell them to Wall Street and other investors.

Throughout the 1990s, Fannie Mae and Freddie Mac have pushed hard to make low down payment loans more available, but the effort really picked up steam in the last couple of years. And thanks to rising demand from lenders, the agencies’ guidelines have gotten increasingly generous.

Among the best

Among the best available are Fannie Mae’s Flexible 97 and Freddie Mac’s Alt 97. The “97” refers to the amount of the home’s value a lender will extend in the form of a mortgage. Like earlier loans backed by the agencies, these mortgages require only a 3 percent down payment. But the new programs aren’t restricted to people with low or moderate incomes, and they don’t require the down payment to come directly from the borrower.

“This is one that doesn’t have to be your own funds,” says Fe Morales Marks, vice president of Fannie Mae’s national housing impact division. “It can come from grants, any government or nonprofit source, from relatives or from employer assistance.”

The Fannie Mae and Freddie Mac programs also lower the amount of the loan’s balance that has to be covered through private mortgage insurance, meaning consumers don’t pay as much in premiums from month to month when they have less than 20 percent of the purchase price on hand. In both cases, only 18 percent of the balance must be insured.

A good deal

The programs can be a good deal for people caught in a market where home prices are rising significantly, says Charlotte O’Donnell, housing program manager for the Consumer Credit Counseling Service in Denver. If prices are clambering upward each month, for example, it can be difficult to ever put together 20 percent for a down payment on a conventional mortgage.

Before jumping in, however, people should make sure their finances will allow them to cover monthly mortgage payments, O’Donnell says. That’s especially true if the mortgage payment would be much greater than the borrower’s current monthly rent. A lender can help with the calculations, as well as an overview of the loan details.

Finally, borrowers should accumulate at least one or two months worth of mortgage payments, even if they can’t amass a down payment, she says. That will help stave off delinquency if some unforeseen problems arise.

“A lot of people are out there needing this,” she says. “The only concern I have is if the person doesn’t get that education, and someone is encouraging them to get into these low down payment programs.”

What to expect

The cost of not having 20 percent up front can add up to tens of thousands of dollars down the road. Not only does a monthly premium for private mortgage insurance get tacked onto the normal payment, but borrowers can expect a slightly higher interest rate because Fannie Mae and Freddie Mac extract a surcharge from the lender when they buy the loan.

Consider a typical $100,000 30-year mortgage on a $125,000 property with $25,000 down. The total interest would be $128,730.

Someone getting a 3 percent down Fannie Mae- or Freddie Mac-backed loan on the same home, would be paying about $51 a month in private mortgage insurance, as well as principal and interest, says Geoffrey Cooper, a spokesman for MGIC Investment Corp. That means they would pay $45,706 more than a conventional mortgage borrower.

The loans “allow borrowers to get into homeownership with even less down, and they increase the flexibility of down payment by allowing them greater flexibility in the source of the money,” says Cooper. MGIC, based in Milwaukee, is a private mortgage insurance company that collects PMI premiums from low down payment borrowers and uses them to insure lenders against delinquencies.

But “our experience has always shown that borrowers with less equity are more susceptible to walking away when tough economic times hit. If there is no equity in your home, there is less incentive to keep that home.”

80-10-10 loans

An alternative for someone with a 10 percent down payment on hand who doesn’t want to spend money on the insurance peddled by MGIC and others is the “80-10-10 mortgage.” This program involves taking out a first mortgage loan for 80 percent of the home’s value and either a home equity loan or line of credit for 10 percent of the value. The remainder is the borrower’s down payment.

“It’s for the customer that wants to avoid PMI, so instead of paying the private mortgage insurance on a monthly basis, they’re going to get a home equity line of credit to cover anything above 80 percent,” says Ann Roess, director of lending services for San Francisco-based Homeshark Inc. The company resembles a traditional mortgage broker, matching borrowers with lenders for a fee over the Internet.

Assuming the same conditions as before, and a 15-year home equity loan with a balloon payment due at the end, a borrower would pay $16,137 more in interest on an 80-10-10 than a conventional mortgage. The interest would be tax-deductible, though, and someone in the 28 percent federal tax bracket would reduce their cost by $4,518 over the 15 years through deductions.

Depending on the lender, there might be some closing costs associated with the second loan that go above and beyond costs on the first, Roess says. And there would still be almost $10,000 in principal on the second loan to either refinance or pay off at the end of its term.