Cost Comparison: Low Down Payment Mortgages

Several years ago, there were many options available to consumers who wanted to purchase a home with little or no down payment.  While fewer choices remain today, there are still several mortgage programs that allow Borrowers to own a home with little or no up-front cost.  FHA, VA, USDA and Conventional financing programs all allow for low down payments (or no down payment at all).

Following is a discussion of the costs associated with obtaining a low down payment mortgage including:

• down payment requirements
• mortgage insurance
• interest rates
• allowable seller contributions

USDA Guaranteed Rural Housing

For those who qualify, The USDA Guaranteed Rural Housing program is usually the least expensive mortgage available.  The USDA GRH is intended to provide home ownership opportunities to middle-income borrowers in rural areas.

Borrowers must purchase a home in a rural area and have income that does not exceed 115% of the median income for that area.  All of Jefferson and Clallam counties are considered rural.  In both counties, the maximum income allowed for a USDA GRH loan is $73,600 (for a 1-4 person family).  Certain deductions can be made for dependent and child care expenses, so be sure to check with your mortgage loan officer if you're considering a USDA GRH loan.

The USDA also has an Income and Property Eligibility web site.  Be sure to select options for the Guaranteed Rural Housing Loan Program if using this site.

The USDA GRH mortgage does not require a down payment.  Interest rates are competitive.  And there is a 2% Guarantee Fee due to USDA at the time of loan closing.  The fee may be financed into the loan.  There is no monthly mortgage insurance requirement for USDA GRH loans.

Closing costs may also be financed into the loan (as long as the loan amount doesn't exceed the appraised value of the property by more than 2%).  Or the Borrower may choose to pay closing costs with his/her own funds or with eligible gift funds.  He/she may also negotiate for the seller to pay all or part of the closing costs (including the Guarantee Fee), usually up to 6% of the purchase price.

While Borrowers don't have to be first time homebuyers to qualify for the USDA GRH, they cannot currently own adequate housing within a reasonable commuting distance.

VA Loans

Mortgage loans insured by the VA are also an excellent option for those who qualify.  Generally, a Borrower must be a current or honorably discharged member of the armed forces or the unmarried, surviving spouse of a qualified veteran.

The VA mortgage does not require a down payment, although the veteran may choose to make one.  Interest rates on VA loans are comparable to other government insured loan programs.  The VA requires an up-front Funding Fee which ranges from 1.25% to 3.30% depending on the type of veteran (regular military or reserves/national guard), down payment, and whether or not the veteran has previously obtained a VA insured mortgage. The Funding Fee may be financed into the loan.  There is no monthly mortgage insurance requirement for VA mortgages.

Closing costs for VA loans may be paid by the veteran or by the seller of the property.  Closing costs may not be financed on purchase transactions.

FHA Mortgage

The FHA mortgage is an excellent option for most borrowers.  There are no restrictions on income, status as a veteran, or property location.  Qualifying guidelines are also generally more lenient than conforming programs.

FHA requires a down payment of 3.5%.  Interest rates are competitive.  FHA currently requires a 1.75% up-front mortgage insurance fee to be paid at closing on purchase transactions.  That fee will increase to 2.25% on April 5, 2010.  The up-front mortgage insurance fee may be financed into the loan.

FHA also has a monthly mortgage insurance requirement.  That requirement is currently .55% of the loan amount for most loans (those with terms greater than 15 years and down payments of less than 5%).  Monthly mortgage insurance costs are added to the borrower's regular monthly payment.

Closing costs for FHA loans may be paid by the borrower or by the seller of the property.  Currently, sellers may not pay closing costs in excess of 6% of the purchase price.  Closing costs may not be financed on purchase transactions.

Conventional Programs

In addition to government insured programs, many lenders also offer conventional mortgage programs with low down payments.

Qualifying for these programs can be tricky.  Lenders are able to provide low down payment options because private mortgage insurance companies are willing to insure the lender against loss.  Since these MI companies insure the loans, they also have their own guidelines regarding the types of loans they will insure.  Therefore, a borrower often must meet the guidelines of three different entities in order to qualify for any conforming loan that requires mortgage insurance:

• guidelines established by Fannie Mae and Freddie Mac,
• guidelines established by the individual lender, and
• guidelines established by the private mortgage insurance company.

It is not unusual for a lender to have more restrictive requirements than FNMA or FHLMC.  For instance, FNMA allows financing of manufactured homes.  Many lenders do not.

In addition, each private mortgage insurance company has its own set of guidelines.  For example, MGIC will provide mortgage insurance on a condominium with a 5% down payment.  RMIC requires a 10% down payment on condos.

To complicate matters even further, each private mortgage insurance company has their own "declining markets" list.  If the company has determined that a particular county or metropolitan area is experiencing declining real estate values, their guidelines are more restrictive for properties in those areas.  And each MI company has a different list.  At AIG, King County, Washington is considered "stable."  But MGIC and PMI have both determined that King County is in a declining market.  Luckily, every MI company that I checked considers Jefferson and Clallam counties to be in stable markets.

That being said, a borrower with great credit (700 credit score or above) and a low debt-to-income ratio (41% or less) may be able to obtain a FNMA "Flexible 97" conventional loan with only 3% down.  Interest rates for low-down-payment conventional loans are slightly higher than government interest rates.  There is no up-front mortgage insurance fee.

Conventional loans do require monthly mortgage insurance premiums.  That requirement is currently .88-.98% of the loan amount for loans with interest rates fixed at least five years and down payments of 3%.  Monthly mortgage insurance costs are added to the borrower's regular monthly payment.

Closing costs for the FNMA Flexible 97 conventional loan may be paid by the borrower or by the seller of the property (up to 3% of the purchase price).  Closing costs may not be financed.

Comparing Options

Clearly, for those borrowers who qualify, the USDA GRH and VA programs offer the least expensive financing.  However, many borrowers must choose FHA or Conventional financing for the simple fact that they are not purchasing a home in a rural area or are not qualified veterans.

Why might a borrower choose a Flexible 97 conventional loan over an FHA loan?  In most areas of the country, the maximum allowable FHA loan for one-unit properties is $271,500.  The maximum allowable conventional loan is $417,000 for the same property type.  In these areas, a borrower wishing to purchase a higher priced home may not have the option to utilize the FHA program.

In many high cost areas, however, the FHA loan limit is higher than (or comparable to) the conforming loan limit.  In Jefferson County, the FHA loan limit is $437,500.  In Clallam County, the FHA limit is $383,750.  In these high cost areas, the FHA loan is a less costly alternative to the conforming program.

In addition, borrowers wishing to reduce their loan balance quickly, may also wish to choose a conventional mortgage option.

*Crunching The Numbers: All calculations presume a fixed rate mortgage with a 30 year term, purchase transaction, owner occupied, 700 credit score, single family detached residence, located in Jefferson County, Washington. USDA GRH example includes interest rate of 4.75%, APR of 5.088%, and guarantee fee of 2% financed into the loan. VA example includes interest rate of 4.75%, APR of 5.049%, and funding fee of 2.15% financed into the loan (the fee for regular military; first time use). FHA example includes interest rate of 4.75%, APR of 5.330%, up-front MIP of 2.25% financed into the loan and monthly MI of .55%. Conventional example includes interest rate of 5.125%, APR of 5.693%, and monthly MI of .98%. All examples include estimate of $600/year for hazard insurance and $2,400/year for property taxes. Cost comparison includes monthly MI payments for 60 months. Loan balance assumes all payments were made on time and no additional amounts were paid towards principal. Calculations do not include closing costs or pre-paids. All interest rates quoted were available on February 11, 2010.