Traditionally, a person buying a home has saved enough money to make a substantial down payment towards the house they plan to purchase. To avoid expensive PMI (private mortgage insurance), lenders require homeowners to put 20% down. If you buy a home valued at $200,000, you need to have $40,000 available for the down payment. If you do not have this much, your loan will require the payment of PMI. PMI can raise your mortgage payment by hundreds of dollars. While lenders will offer loans to those who do not have the full 20 percent down payments, there are additional fees that must be paid in order to receive a low down payment mortgage.
PMI is handled through three federal banks:
- Fannie Mae
- Freddie Mac
- Ginnie Mae
PMI is a way banks can protect themselves. When you buy a car, you purchase car insurance in case of an accident. Banks require private mortgage insurance when a borrower lacks a substantial down payment to protect themselves from loan defaults. In this case, the lender passes on the private mortgage insurance costs to the borrower. Your PMI payment protects the bank from high legal fees if you do default.
When you do not have 20 percent to pay towards your new home, you will need to apply for a low down payment mortgage. Low down payment mortgages are for those who can pay no more than five percent down. One of the most common low down payment loans is the three percent down program offered by many mortgage lenders. You need only come up with three percent of the purchase price, and you borrow 97 percent of the purchase price. This makes it much easier for first time homeowners to afford a new home. To qualify for a low down payment program, you must have:
- An income high enough to cover the monthly mortgage and insurance payment.
- Cash to cover the three percent down payment and the closing costs.
- Decent appraisal value that proves you are not borrowing more than the home is worth.
- Good credit score
- Money to cover the first month's mortgage payment.
You will still be required to make payments for PMI. Other costs include:
- Loan application fees (appraisal, application fees and credit report fees)
- First months mortgage payment
- Homeowner's insurance
- Realtor commissions
- Legal fees
Many banks require your intended home meets their guidelines.
- Home must pass a home inspection.
- Home cannot be in a flood zone unless you are carrying flood insurance.
- Electrical system must be up to code.
- Plumbing system must be up to code.
- Heating system must be in great condition.
A home inspection is a great idea anyway because it protects you against unforeseen events. A home inspection will tell you if there are items that will need repairs or replacements in the near future.
If you have an income that is low enough to qualify, FHA and VA offer programs that can help you purchase your first home without requiring a hefty down payment. FHA works with a number of other companies who offer grant money to first time homeowners who cannot come up with the substantial down payment by themselves. These free grants are a great way for low income or disabled homebuyers to come up with the money they need to by a home they can afford.
With piggyback loans, those who cannot afford the down payment take out a mortgage for 80 percent of the home's value and then borrow against the house's equity to come up with the remaining purchase price. These loans can be risky because, while you avoid the costly PMI rates, you then have two loans to pay. Failure to pay even one of the loans can lead you to lose your home.