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A Mortgage’s Downpayment: Should It Go Higher or Lower?

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Bank of America CEO Brian Moynihan recently talked about lowering the standard downpayment on homes to 10% from 20%. If applied, it could certainly boost homebuying by millennials whose homeownership rate is the lowest among the five age groups.

Pending the mortgage industry’s action on Mr. Moynihan’s suggestion, let’s discuss the role the size of downpayment plays in today’s mortgages.

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The 20-Percent Downpayment Standard

Mr. Moynihan in an interview with CNBC believes that the move to lower the standard downpayment would not introduce much risk to lenders but would help more consumers get mortgages.

While lenders and mortgage programs as discussed below require varying downpayment sizes, 20 percent of the home’s purchase price is considered a gold standard in the industry. This rule is based on the guidelines set by government-sponsored entities, Fannie Mae and Freddie Mac.

So that lenders can sell their mortgages to either GSE, they must conform to their underwriting standards, downpayment and all. Fannie and Freddie are the biggest purchasers of mortgages in the U.S., selling to either entity will enable lenders to recoup funds they can lend to other borrowers.

Putting 20% of the home’s purchase price is beneficial to homeowners, too.

  1. There’s no private mortgage insurance. An insurance meant to protect the lenders in the event of default, PMI is separate from the compulsory homeowner’s insurance. The PMI may be added to your monthly mortgage premium, paid upfront or both as required by the lender.
  2. There’s a higher chance of getting approved. A higher downpayment lowers the risk for the lender to make the loan. A big plus, so to speak, to your loan application.
  3. There’s a smaller loan to take out. With you contributing 20% of the home’s price tag, you’ll only be borrowing the remaining 80%. This lessens your monthly payment. Say you take out a 30-year loan on a home worth $200,000 and then put down 20% ($40,000) at 4.02%, you’ll get a monthly payment of $766. With a 0% down, your monthly payment will be $957.
  4. There’s a lower interest rate to pay for borrowing. Because of the lower loan amount, thus the lower risk for the lender, a mortgage with a 20-percent down has a lower interest rate.
  5. There’s equity already stored in the home. Equity is pretty handy when you refinance your existing mortgage and do a cash-out refi. Having a 20% equity early on in the home can help mitigate the ill effects of declining home values.

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Less Than 20%?

For all its benefits, the 20-percent standard can be too high a hurdle for homebuyers to overcome. Partly to encourage more first-time homebuyers, there are mortgage programs that ask a downpayment below that threshold.

First off our list are low-downpayment mortgages from FHA. Its mortgages can require as little as 3.5% of the purchase price. FHA loans are also lenient to first-time homebuyers with not-so-high scores and high debt-to-income ratios. An FHA loan has mortgage insurance premiums, which are paid upfront and on a monthly basis.

Then there are conforming loans specially made for first-time homebuyers from Fannie Mae’s HomeReady™ with 3% down and Freddie Mac’s Home Possible™ with 3% to 5% downpayments.

Conventional loans, which don’t conform to GSE standards and not part of government programs, can also be taken out with less than 20% down. You’ll need a PMI though.

Who would forget 100-percent mortgage financing for veterans and families in rural areas? The VA and USDA loans require little to no downpayments to better serve their targeted demographics. Each loan program does not require a mortgage insurance but a funding fee for VA loans and a guarantee fee for USDA loans, respectively to cover losses in the event of default.

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One Major Benefit of Non-QMs? No PMI!

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One Major Benefit of Non-QMs? No PMI!

Sure some loans cost a lot upfront with down payments as big as 40%. But these loans, e.g. stated income loans and jumbo loans, don’t carry a private mortgage insurance. PMI, which is required when you put down less than 20% in equity, will be included in your monthly mortgage payments. While other homeowners are finding ways to get rid of it, you don’t even have to worry about it when you get a nonqualified loan. Finding lenders is effortless, too.»

Private Mortgage Insurance: Why It Matters Not to Have One?

To be fair, PMI is useful for those who can’t produce or save up that much cash even with gifts for a down payment. They can still get a mortgage but they would have to protect the lender in the form of the private mortgage insurance.

Being your-not-the-usual mortgages, nonqualified loans generally require 20% upward for down payments. This spares their borrowers from the less savory aspects of the PMI, as follows.

1. It’s expensive. The PMI is usually between 0.50% and 1% of the loan amount. Supposing you took out a 5% down $100,000 mortgage and your insurance rate is 1%. That means $1,000 goes to your PMI a year or $83 is being added to your monthly mortgage payment.

While the most common way to pay the PMI is on a monthly basis, other lenders require that the PMI be paid upfront at closing. Some lenders may be the one to make the payment upfront but this cost will be passed on to you in the form of a higher rate.

Other mortgages like FHA loans require mortgage insurance premiums to be paid upfront at closing and in monthly fees.

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2. It’s not for you and won’t benefit you. You pay for a mortgage insurance as protection for the lender in the event you default on your loan. Neither you nor your children benefit from the PMI after you finish paying off the mortgage.

3. It’s difficult to cancel or terminate and in some cases, will remain. PMI can be removed if you have built 20% equity into the home or paid down your mortgage that you only owe 80%. In that case, you have to request the lender to cancel the mortgage insurance. Conventional lenders are required to terminate the mortgage insurance if your loan balance reaches 78%. Until your balance reaches any of those levels, you have to continue paying for the mortgage insurance.

The case with FHA loans is more complex as the annual MIP can be canceled if the loan is originated before June 3, 2013 and the unpaid balance is 78%. But the Upfront MIP portion of the FHA mortgage insurance premium is not cancelable.

Are you up for paying a large down payment now to avoid PMI or putting less down payment and pay a mortgage insurance later?

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A Roundup of Mortgages for Today’s Self-Employed

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a-roundup-of-mortgages-for-todays-self-employed

It’s not that they don’t have adequate income/assets to take on a mortgage. It’s just that self-employed borrowers can’t show in pay stubs, Form W2s, and sometimes tax returns their ability to repay their loans. There are a number of mortgages that are made for or admit the self-employed professionals of today. Here’s a non-definitive list of loans starting from those requiring no income verification.

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Option 1: No Income Verification Loans

Also known as no doc and stated income loans, these mortgages are underwritten based on your credit score, employment history, and down payment. Credit scores required can be in the 700 range and equity at 40%.

Lenders will verify your self-employment and in lieu of W2s and pay stubs, your personal and business bank statements good for a year. These bank statements should match your income statements.

With the financial regulatory reform of recent years, stated income loans are not the liar loans of the past. Their documentation may not be full but lenders compensate it with other factors as mentioned above.

Option 2: Bank Statement Loans

These loans are akin to stated income loans, requiring a 12-month history of individual and/or business bank statements. LTV can be between 75% and 80% as it varies per lender.

Typical requirements are business license and related permits, tax returns and tax return transcripts. There may be other requirements that depend on, among other things, the length of your self-employment history, e.g. two years or less.

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Option 3: Conventional Loans

While loans sold to GSEs Fannie Mae and Freddie Mac require full documentation (they still do), they have loosened up their guidelines for the self-employed.

For Fannie Mae’s part, a self-employed borrower’s income can be verified using his/her individual or business tax returns or both for the past two years, as applicable. The self-employed borrower, which is defined by Fannie as “ any individual who has a 25% or greater ownership interest in a business,” will need to show two years’ worth of prior income as proof that this source of earnings will likely continue. Those who have been self-employed recently may provide their latest federal tax returns.

Back in September, Freddie Mac introduced a pilot program for first-time homebuyers with low income and alternate income sources like self-employed professionals.

Option 4: FHA Loans

Two years seems to be the “magic” number for mortgages for the self-employed as FHA loans also require that you should have a steady flow of self-employment income for the last two years. This will be shown by duly signed and dated tax returns and schedules for the past two years. Income statements and balance sheets are also required.

Take note that the FHA requires full documentation but the perks can be worth it. For one, your down payment could be as low as 3.5% depending on your credit score.

These are just some options that you can look into when shopping for mortgages. Lenders may offer you other options, talk to one today!»