After the housing market crashed in 2008 and 2009, a lot of people heard about how the proliferation of low- and no-down-payment loans contributed to a housing market where millions of consumers had little or no equity in their homes. These low-down-payment loans were criticized, and some lenders severely reduced or eliminated them. Low down payments might not be the right answer for every homebuyer, but it’s important to understand when they are a good choice and when you’re better off putting some extra money down.
The most common low-down-payment loan for homeowners is through the Federal Housing Administration (FHA). FHA loans offer buyers the opportunity to purchase a home with as little as 3.5 percent down payment. As home prices continue to rise, the prospect of needing 10 or 20 percent to put down can put the dream of homeownership out of reach for many first-time homebuyers. In these cases, a low down payment option might be the best way to purchase a home.
Another reason a homebuyer might opt for an FHA loan is that they would be otherwise unable to qualify for a loan through traditional means, often because they have a debt-to-income ratio (or DTI) that would make lenders wary of lending to them. DTI is a measure of how much money you own on your monthly debt obligations compared with your monthly income, and if the ratio is unfavorable, you will either be denied a loan or will end up with a higher interest rate. This also allows you to keep more of your current money to pay down your debt, rather than putting it down on a home.
There are some other advantages to putting only a small down payment on your home, and perhaps the biggest is keeping more of your money. Even if you have enough to put 10 or 20 percent down on a home, it’s not always the best choice. Keeping some of the money in savings can help you remain flexible in case of an emergency, job loss, or other investment opportunity that comes along.
The key difference between someone who is able to qualify for a conventional loan with 10 or 20 percent down and someone who gets a loan with a low down payment is private mortgage insurance (PMI). PMI emerged in the wake of the housing crisis as a way for lenders to protect against homeowners whose home values went down and they had no equity, leaving them “underwater” on their loan.
Premiums on PMI have increased over the past few years, and fees have gone up as well as a way for the U.S. Department of Housing and Urban Development (HUD) to shore up its insurance fund with more and more borrowers turning to FHA loans. Other recent changes to the PMI process include higher fees up front, and the requirement that borrowers pay PMI for the entire life of the loan.
If you are considering a low down payment loan, it’s important to talk to a mortgage lender in Salt Lake City about all the options available so you can determine which one works best for your financial situation.