May 6, 2017

Loans

Mortgage Loan Options

1. Get an FHA mortgage

FHA mortgages are insured by the Federal Housing Administration. A common misconception is that this loan is specifically for first-time homebuyers, but the truth is anyone can apply — even repeat borrowers. And the best part? FHA loans only require a down payment of 3.5 percent with a minimum credit score of 580. If your credit score is below 580, your lender will require a 10 percent down payment — still much less than the traditional 20 percent down. Just keep in mind that you'll have to go to an FHA-approved lender to qualify, and not all FHA-approved lenders will offer the same interest rate.

There are some additional costs with an FHA loan. First, you'll pay an upfront premium of 1.75 percent of your total mortgage loan. Second, you'll pay mortgage insurance premiums, or MIP, for the life of the loan. With a conventional loan, mortgage insurance is temporary and the payments typically stop once you build your home equity to 20 percent. With an FHA loan, however, that's not the case. To drop mortgage insurance with these loans, you'll need to refinance once the property has sufficient equity.

The thought of coming up with a down payment is nerve-wracking for many would-be home-buyers. Some people think they absolutely must have at least 20 percent down to purchase a home. If they don't have anything close to this amount in savings, they give up on their dream of ownership.

This doesn't have to be the case, however. Despite what you may have heard, a 20 percent down payment isn't written in stone. There are several other options you can consider. (See also: 5 Ways to Qualify for a Mortgage With a Small Down Payment)

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2. Apply for a Conventional Home Loan

Like FHA mortgages, conventional home loans allow you to purchase a property with less than a 20 percent down payment. Standard conventional loans require a minimum down payment of 5 percent, but some specialized conventional products allow down payments as low as 3 percent. Note that these programs typically have income restrictions and often only accommodate first-time homebuyers (including borrowers who haven't owned in the past three years).

One example is the Fannie Mae and Freddie Mac-backed Conventional 97 purchase program. Again, some restrictions apply: Both repeat borrowers and new homeowners can purchase a home for 3 percent down, assuming they're using the program for a 30-year fixed-rate mortgage on a single-unit primary residence. The program is limited to loan sizes of $424,100 or less. You'll also need a credit score of at least 620 to qualify for any Fannie Mae-backed loan.

3. See if you're eligible for a USDA or VA loan

Zero-down mortgages became practically extinct after the housing crisis, but you can still find some programs offering 100 percent financing. For example, eligible veterans and active-duty military can apply for a VA-guaranteed home loan and purchase a property with no down payment and minimum closing costs.

My husband and I qualified for this type of loan for our first home purchase. We had to jump through plenty of hoops to nail it down — the qualifications changed midway through our process, requiring us to redo all our applications. It was worth it in the end, however, considering we didn't have enough for a down payment.

Another zero-down option is a USDA Rural Development Guaranteed Housing Loan, which is backed by the U.S. Department of Agriculture. To qualify for this loan, though, you must meet set income requirements and purchase a home in an eligible rural area.

Neither USDA loans nor VA loans have mortgage insurance. Instead, they come with an upfront premium or funding fee, generally somewhere between 1.25 percent and 3.3 percent of the purchase price of the home.

What to consider when making a down payment

There are a few things you need to consider before deciding if a lower or higher down payment is the best choice for you.

If you can afford to give the bank 20 percent down and maintain some cash in savings, a higher down payment is a smart move. You'll want to make sure a home purchase doesn't completely drain your savings, because additional, unforeseen costs will inevitably pop up. I can almost guarantee it, and being house poor isn't fun. If putting 20 percent down will wipe out all your cash reserves, a lower down payment is the safer choice. (See also: 4 Easy Ways to Start Saving for a Down Payment on a Home)

Just be aware that putting less than 20 percent down means you'll then need to take out a bigger loan, which will result in a larger monthly mortgage payment. A smaller down payment can also result in a slightly higher interest rate. There are no hard or fast rules regarding how much your interest rate could increase. However, even a slight increase from 4 percent to 4.25 percent on a $200,000 30-year mortgage can result in paying an additional $30 per month.

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