Intro to the World of Mortgages
The world of mortgage products is vast and can be overwhelming. As a borrower, it’s nearly impossible to sift through everything that’s available. If you talk to one bank, they can only give you “x”. Then you talk to a mortgage broker and suddenly they are telling you about a million and one products you’ve never heard of. Since I work for a mortgage broker, I can tell you one of the main reasons you’ll find we have a wide offering of products is due to the fact that we work with multiple lenders (I have access to over 30 different lenders currently). A traditional bank is often times their only lender – they aren’t brokering the deal. They are originating your mortgage AND funding your mortgage. Therefore they may offer a smaller variety of products or may have stricter guidelines. It really all depends on your specific situation, so don’t be afraid to shop around!
One of the biggest questions I get is on the down payment. When you are purchasing a home, you’ll be asked right away how much money you are planning to put down. This money decreases the amount of money you are borrowing (meaning your loan amount will lower with each additional dollar you want to put down on a home). I am asked so often about low or no down payment loans. The down payment can be a large sum of money for sure! It’s great to know what your options are and what will work best with your specific goals.
Closing Table Costs
First, I want to pull apart the different costs that are paid at closing. It’s good to know what’s what!
- Down payment – These funds go directly towards the house. Your down payment will decrease your loan amount, thereby saving you money over the life of the loan. The less you borrower up front, the less you pay in interest every month!
- Closing costs – This consists of costs such as the attorney fees, title charges, processing fees, lender fees, points (if you chose to pay them), appraisal cost, etc.
- Prepaids & Escrows – This is a big one! Prepaids & escrows can be pretty high depending on where you live and the type of home you’re buying. Your lender does NOT have control over these fees. Your real estate agent does NOT have control over this total either. Prepaids and escrows refer to homeowners insurance and taxes. Your agent and loan officer should be able to provide you with some referrals for insurance agents for you to reach out to (maybe you’ll save a few dollars that way!). In general, you’ll need to pay the annual premium up front and start your escrow account with 3 or so months of payments. When it comes to taxes, the amount you pay up front depends on how often the town collects taxes and how much tax they charge for that specific house. A lot of towns collect taxes semi-annually but a quick Google search will tell you what specific towns are doing. For purchases, I’m usually estimating 8-9 months of taxes being due at closing depending on the month you are closing in. A portion of that is going to start your escrow account.
***Taxes can vary quite a bit from house to house, even within the same town! I’ve seen a lot of confusion over this in the past. When you are talking with family or friends about what they paid at closing, keep this in mind. These amounts are out of the control of your loan officer and real estate agent but can often total $8,000 or more!
Closing costs, prepaids and escrows can typically be rolled into your loan amount with most mortgage products (including refinance loans). So don’t freak out when you see the estimates for these costs! There are a couple of ways your loan officer can structure your loan to ensure you don’t come out of pocket all the way for these items.
Pros to Making a Down Payment (regardless of size)
There is a lot of misinformation out there when it comes down to the minimum down payment requirement. There are SO many loan options and down payment requirements will differ from product to product. As you will see in just a few paragraphs, there are widely available loans that do not require any down payment!
A big pro to making a down payment (no matter how big or small) is that you have just built up some equity. For the first several years of home ownership, most of your monthly mortgage payment is going towards interest – NOT towards paying down your principal balance (the amount of money you actually borrowed). If you didn’t make a down payment, you won’t have any home equity to tap into for quite a while.
Down payments also decrease the amount of money you borrow which then decreases the amount of money you pay over the life of the loan. Even putting down an extra $1,000 can save you tens of thousands of dollars. Depending on your situation, saving a little money up front may not make sense when you could be saving immense money over the long run.
Lenders will often offer lower interest rates the higher the down payment. In general, an increased down payment will show you are more invested in the home and thereby less of a default risk. This makes sense because you’ve invested more of your own funds up front. While this may not always be the case, it is worth asking your loan officer if your interest rate will decrease at all if you put down more funds. You may be surprised! I’ve seen interest rates drop with just a 1% increase in the down payment. It’s definitely worth asking!
If you are putting less than 20% down, you are more than likely going to be paying monthly mortgage insurance. However the monthly amount will decrease the more money you put down. This decreases the amount of money you are paying each month AND you will see the mortgage insurance drop off sooner with a larger down payment (you’ll reach that 80% loan-to-value faster!). Not every mortgage will allow for the removal of mortgage insurance! For example, FHA mortgages have mortgage insurance attached for the life of the loan. Ask your loan officer to learn the specifics for the mortgage you are applying for.
Cons to Down Payments
There are really only two solid cons I have to making a down payment. The first is that the funds for the down payment need to be both sourced and seasoned. You can’t use “mattress money” for the down payment. Lenders are very strict when it comes to safeguarding against fraud and illegal activities, which large cash deposits can be indicative of. If you don’t have the down payment saved up in a bank account, this could be a roadblock for you.
The other con is that the down payment is expensive and can potentially eat away a large chunk of savings. If there are immediate, large expenses you are anticipating, you may want to consider no down payment options.
No Down Payment Options
The most universal and easily available options are USDA loans and VA loans. There may be other options available to you depending on the state you are looking to buy a home in.
USDA – United States Department of Agriculture
- Credit score minimum is 620.
- Upfront mortgage insurance fee of 1% of the loan amount. This is usually rolled into the loans so it will not increase what you come out of pocket for at closing.
- Monthly mortgage insurance fee of 0.35% of the loan amount.
- Household income limits set at 115% of area median income. For income limits, check here.
- Income limits do mean this is geared more towards low to moderate income borrowers.
- Short course on home ownership is required.
VA – Veterans Administration
- Required to be active duty or retired military member or eligible family member.
- Will need an eligible COE (Certificate of Eligibility).
- There is a funding fee required with this loan. The funding fee can be rolled into the loan amount so out of pocket loan costs are not increased. This fee is generally 2.15% for first time users and 3.3% for repeat users. Borrowers with service related disabilities are often exempt from this fee.
- No monthly mortgage insurance.
- Minimum credit score requirement of 560 – Not all lenders will accept scores below 600. There can also be increased requirements for lower credit scores.
- Higher debt to income allowances – maximum debt to income will differ based on credit score and residual income amount.
Is a no down payment loan right for you?
There are definitely a lot of specifics that go into determining the right mortgage for someone. I love VA and USDA mortgages – they really are great products and offer so many incentives outside of “no money down”. You can also choose to utilize a down payment with both of those options! You may actually see interest rates drop even more when doing so.
If you are a well-qualified borrower but just don’t have money in the bank, it could make sense to take advantage of a loan that offers 100% financing. Using 100% financing can also make sense if you are planning to stay in a home for a very long time. When you sell a house, you do need to consider a breakeven point. You will incur closing costs again and you are probably going to want to pay off the mortgage in full. You generally do not begin paying down the principal balance until you are 5 years into your loan.
When should you consider making a down payment, no matter how small?
If you have money saved, definitely consider putting some of that towards your down payment. Saving a few thousand up front does NOT translate to long term savings. This will actually cost you a good deal of money.
Not every home comes exactly how you want it to look. If you are considering renovations down the line, you will want to make a down payment in order to jumpstart equity building. This will enable you to do a cash out refi or HELOC down the road to cover the costs of renovations.
If you are thinking you may not be in the area for more than 5 years, it’s going to make sense to do a down payment. This will help to safeguard you from needing to come out of pocket for additional closing costs when you sell your home.
The products available to loan officers are constantly expanding. So it’s always worth asking if there is something new that could work for you if you’ve been searching for a home for a while! If you are eligible for multiple loan products, and you aren’t sure which direction to go in, ask your loan officer for some amortization charts! These will show how much you pay over the life of the loan. You’ll be able to see total principal, interest and mortgage insurance payments. You’ll also be able to look at the payment schedule and see what year your principal payment begins to exceed your interest payment.