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Peter Miller

Small Down

By Peter G. Miller
CTW Features

Question: We are first-time home buyers. We are open to an FHA mortgage, but our lender says we also should look at some new mortgages with 3 percent down. What’s the difference between the FHA program and these new loans?

Answer: The FHA program has been with us since the 1930s and is the traditional go-to mortgage choice for many first-time buyers. The reason is that FHA loans require just 3.5 percent down, have no pre-payment penalties and offer liberal qualifying standards.

The FHA doesn’t actually fund mortgages, instead it insures them. If the loan sours, the FHA steps in to pay off the lender. There is a cost for this insurance, currently 1.75 percent for the up-front mortgage insurance premium (the up-front MIP) and .85 percent for the annual mortgage insurance premium (the annual MIP). The up-front MIP can be added to the loan amount so it’s not a cash cost at closing, but it does increase the loan size.

Recently a number of private-sector mortgage programs with just 3 percent down have begun to pop up. Known by various names, such programs are attractive because in many cases there’s no cost for mortgage insurance.

Imagine that you want to borrow $150,000. With the FHA the up-front MIP would be $2,625 plus roughly $1,275 for the annual MIP. With a private-sector plan these costs can be eliminated. Reduce the insurance cost and cut the down payment requirement by .5 percent ($750 in this example) and borrowers have some attractive savings.

Are private-sector loans with little down easy to get? Maybe yes, maybe no. Here are the ten basic questions to ask:

First, what is the interest rate and APR (annual percentage rate). How do they compare with FHA financing?

Second, what is the monthly cost for principal and interest?

Third, is there an income limitation?

Fourth, is there a requirement for reserve funds? (Whether there is or isn’t a requirement borrowers should always have additional cash available for repairs and emergencies.)

Fifth, are borrowers required to take a HUD-approved home ownership class? If yes, take it. These are very short classes that can substantially reduce borrowing costs.

Sixth, if you’re a first-time buyer, ask if the lender will accept “non-traditional” forms of credit to support your mortgage applications, items such as utility bills and rental checks.

Seventh, does the down payment have to come from you exclusively or are gifts and grants allowed?

Eighth, must you be an owner-occupant? Expect the answer to be yes.

Ninth, does the loan allow the borrower to keep all profits from a home sale? Some programs that use government credit have a recapture provision if the home is sold within a certain time period, say nine years.

Tenth, is there a loan size limitation? Expect the answer to be yes.

Private-sector loan options with little down can be very attractive for borrowers, and are worth looking into if you’re considering an FHA mortgage. At the same time, be aware that these loans need to be fully documented – lenders are not handing out mortgage money without a full understanding of the borrower’s ability to repay the loan.

© CTW Features

Peter G. Miller is author of “The Common-Sense Mortgage,” (Kindle 2016). Have a question? Please write to [email protected].