That’s right! Today’s conventional loan requires a qualified borrower to put only 5% down, and an FHA loan only requires 3.5% down.
The National Association of Realtors recently noted that millennials represent the largest share of homebuyers, at 32%, and make up 68% of first-time homebuyers. This may come as a surprise to those folks reading articles about how millenials never buy homes. How can it be that so many millennials — a generation that is moving back in with mom and dad and has historic amounts of student debt — are managing to enter the housing market, even overcoming the mortgage rules of thumb of a 740 credit score, 43% debt-to-income ratio and a 20% down payment on a house?
Here is a closer look at these programs:
FHA stands for the Federal Housing Administration, and its loans help borrowers who have less money to put down or may not qualify for other loan types. Through FHA, the U.S. government provides the lender with borrower-paid mortgage guarantee insurance. This means the borrower has to pay for mortgage insurance for the life of the loan. As a result, lenders are willing to approve borrowers that don’t meet the higher standards for conventional loans.
The primary reason people choose an FHA loan is simple: FHA loans allow you to put as little as 3.5% down when buying a house. FHA loans also offer relaxed credit and debt-to-income requirements compared with conventional loans. This is a prime way millennials are getting into the housing market. FHA also allows the seller to contribute up to 6% of the purchase price towards buyers closing costs & pre-paid items. This is twice the amount allowed on a conventional loan.
The biggest downside can be the cost — government-provided mortgage insurance adds 1.75% to the loan amount and requires a monthly fee of .85% of the loan amount. This monthly fee lasts the life of the loan.
An FHA loan carries mortgage insurance for the life of the loan. The only way to remove it is to refinance to a conventional loan when your home equity has increased to a point that you have an 95% loan-to-value ratio; remember that if you make a 5% down payment on your home, for example, your initial loan-to-value ratio would be 95%. Note that the loan-to-value on an FHA loan is 98.25% at time of closing ( 96.5% + 1.75% upfront fee) on average it takes two years for your loan to be at 95% of the original sales price.
A conventional loan is neither insured nor guaranteed by the federal government, and it must meet guidelines set by Fannie Mae and Freddie Mac.
In general, there’s a limit of $424,100 for single-family homes. In some high-cost counties (counties in CA) the limit can be as high as $625,000.
These loans require that a borrower have a minimum FICO score to qualify. Lenders will have their own minimums beyond the Fannie and Freddie guidelines, but a 620 credit score is often a starting point. A score over 740 will most likely get you the best rates.
There are various loan programs and the minimum down on a conventional loan can be as little as 3%: the so-called “Conventional 97” is backed by Fannie/Freddie, so rates are low, borrowers may receive reduced private mortgage insurance, but income limits do apply per county.
The downside of a conventional loan is that if you use one to buy a house with less than a 20% down payment — meaning your loan-to-value ratio is higher than 80% — you have to purchase private mortgage insurance, a monthly expense which is typically .52% but can be up to 1.5% of the loan amount depending on a borrower’s credit rating.
Make no mistake, putting 20% down is a good idea if you can do it. It’s how you avoid mortgage insurance. But paying PMI for a time might be acceptable if it means actually getting into the housing market and building equity.
Unlike an FHA loan — which carries mortgage insurance for the life of the loan — the mortgage insurance on a conventional loan will fall off as soon as the loan-to-value ratio reaches 78% because of the Homeowners Protection Act. At 80% a borrower can request that the PMI be eliminated.
What this means is that, if your home is appreciating steadily, you’ll be in good position to see your mortgage insurance disappear. Another way to get rid of PMI is to keep track of the comps for recently sold homes in your neighborhood. If you feel that your home is undervalued, you can always order a new appraisal to determine whether your home equity is such that you can eliminate the PMI.
You can also refinance your loan, if rates have dropped, which can both save you money while reducing or possibly eliminating the PMI.
The U.S. Department of Veteran Affairs backs loans as a benefit for active-duty military personnel, veterans and some spouses/widow(er)’s. VA loans come with great terms for those who qualify.
VA loans can be either fixed rate or adjustable rate mortgages. This type of loan can only be used for your primary residence, and you can only have one VA loan at a time.
VA loans have 0% down requirement and do not require mortgage insurance. And while credit scores matter in order to qualify for the program, minimum requirements are currently 640.
You qualify for a VA loan if you are a veteran, active duty personnel in any branch of the U.S. Armed Forces, or a spouse/widow(er) of one.
The take away is that in today’s mortgage environment it is not necessary to make a 20% down payment on a house that will be your primary residence. At Title Mortgage Solution we offer a wide variety of loan programs to ensure we have the best options for our clients. When you sit down with one of our loan officers we will work diligently to find the loan program that is the best fit for your circumstances.