A friend of mine just bought his first home in Washington, D.C., a pretty hot housing market where it's hard to find a decent place for less than $300,000. He's an attorney and his wife is a teacher so, together, they make a good living. But to make the typical 20% down payment on the three-bedroom house they wanted, they would have had to scrape together $100,000.
My friend didn't have $10,000, let alone $100,000. But he also didn't want to spend years saving for a down payment only to miss out on low interest rates and still find himself short of cash because of rising home prices. So he and his wife bought without making a down payment. They settled on a Wells Fargo 80/20 loan -- a mortgage for 80% of the home's value plus a 20% home-equity line of credit. They did have to pay a 1.1% fee, which amounted to about $5,500 for a $500,000 loan.
In the mortgage world, low down payment means putting down less than 5% of the sales price of the house. Putting down less than 5% knocks you out of a "conventional" mortgage, which typically offers the best terms for the borrower.
These mortgages aren't as cheap as they seem. You likely will have to pay a higher interest rate, buy private mortgage insurance (borrowers usually pay 20% of a home's value to avoid this) and make bigger monthly mortgage payments. Plus, it can be dangerous to be so highly leveraged. But in an expensive housing market, it can be the only way to afford a home.
Private lenders
There has been a proliferation of low-down options in the private market in the last decade, says Doug Duncan, chief economist of the Mortgage Bankers Association of America. Most banks offer special mortgages to low- and moderate-income borrowers because the Community Reinvestment Act requires financial institutions to provide a certain share of business to these economic groups. But no- and low-down options for jumbo loans (higher than $300,700) are harder to find.
Countrywide, the nation's leading independent lender, offers a no-down-payment loan of up to $422,300, says Doug Perry of Countrywide's consumer markets division. The loan provides 103% financing to cover closing costs. Wells Fargo has a similar loan, No Money Down Plus.
Nations Home Funding has a zero-down-payment, no private mortgage insurance program for lawyers, doctors and accountants in Arizona, Maryland, North Carolina, Pennsylvania, and Virginia. Loans are capped at $500,000.
Another option is a piggyback, or 80/10/10, mortgage, which avoids private mortgage insurance. Borrowers receive a first mortgage, usually for 80% of the home value, then a second mortgage or home-equity line of credit for 10%. But the buyer has to come up with the remaining 10%. Some lenders are willing to provide up to 20% for the second mortgage to eliminate the need for a down payment.
To qualify for a piggyback or zero-down loan, borrowers must have good credit (see "Know the Score Before You Borrow") and strong income. Some savings are often required, but lenders often relax debt-to-income ratios.
Government programs
Although some government loan programs have income restrictions, many do not. However, they all have loan limits ($300,700 or less). Fannie Mae and Freddie Mac are the privately held companies created by Congress to increase the availability and affordability of homeownership. Both have no- and low-down mortgage products offered through private lenders. Their loans with no income restrictions require a good credit rating (usually a FICO score of 700).
Fannie Mae offers a loan that requires a 3% down payment, Flexible 97, and a zero-down loan, Flexible 100. These loans are offered through Fannie Mae-approved lenders. Freddie Mac offers two similar products: Alt 97 and Freddie Mac 100.
The Federal Housing Administration is not a lender but it insures government-backed loans made by private mortgage companies. By offering mortgage insurance, lenders are able to provide credit to potential home buyers underserved by the conventional mortgage market. Borrowers usually have to pay only 3% of a home's value, and their housing expenses can be up to 29% of their income (more than the usual 26%). There is no income limit, but loan limits range from $144,336 to $261,609. Also, the program requires a more rigorous (and costly) appraisal process than conventional mortgages require.
The Department of Veterans Affairs loan program doesn't require any down payment, eliminates the need for private mortgage insurance and usually offers lower interest rates. However, there is a funding fee of 2% to 2.75%. Only veterans and service personnel are eligible for this program, which provides up to $240,000 to buy or build a home. Loans are available through VA-approved lenders.
Margin loans
If you have securities you don't want to cash out to make a down payment, your brokerage firm might let you pledge securities as collateral to avoid a cash down payment. A Merrill Lynch program requires a pledge of 30% of the loan amount. That will help you avoid private mortgage insurance, but your mortgage payment will be higher with no money down. And you could get a margin call if your account value falls.
For example, Merrill Lynch requires your account balance to be at least 130% of the amount you pledged. If you pledged $90,000 for a down payment, you must have $117,000 in your brokerage account. If your balance dips below that level, you might have to send in more money or start selling some investments.
GETTING STARTED
