It just sounds too good to be true – buying a home with no money down. But that does happen for some people because of loans available with that option. The reality is 60 percent of home buyers bought their homes by paying six percent or less in a downpayment, according to the National Association of REALTORS.
For those thinking about looking into a zero down payment mortgage, you should consider the good, bad and ugly of such a loan.
“Individuals who take on a zero-down mortgage should build up an emergency fund such as six months of expenses and avoid taking on additional debt for a car or credit cards,” says Michael J. Highfield, professor of finance & Robert W. Warren Chair of Real Estate Finance College of Business at Mississippi State University. “They should also start paying extra on their mortgage whenever possible.”
And depending on the loan, they should eventually look for opportunities to refinance into a lower rate product without mortgage insurance, he adds.
“Someone who buys a home at 100 percent financing needs to beware that an adverse movement in housing prices will put them underwater – owing more than the house is worth – quickly,” Highfield says.
Loans and programs offering zero down payments
- There are several different programs which offer zero down mortgage loan programs, some of which are veteran oriented. The Veterans Administration (VA) provides guarantees for qualified members of the military (and military retirees). VA loans do not have mortgage insurance premiums, but they do have a funding fee.
- The US Department of Agriculture offers a USDA Rural Development mortgage guarantee. You do have to be within the USDA income eligibility limits and find a property designated within the USDA map. It is also subject to income limits for the borrower. The loan requires an upfront and annual funding fee.
- The Doctor/Physician Loan Program is a loan program designed for recently graduated dentists and physicians who are starting their careers with student loans. These programs are originated by banks to candidates with high credit scores and income potential, and no mortgage insurance is required.
- There are other lenders, primarily credit unions, who have zero-down loan options, but those opportunities are highly institution specific. For example, Navy Federal Credit Union offers a zero down program which is very similar to the VA program. It is limited to those with military service, their family members, and some civilian military contractors, and it also has a funding fee.
Reasons someone may lean toward a zero down payment
As one would expect, most individuals seeking a zero-down mortgage are those who do not have significant savings to make a downpayment, Highfield says.
Others, like those in the Doctor/Physician Loan Programs, are likely to have significant student loans and need their limited amount of liquidity for commercial/business loans and not mortgage loans,” he adds. “Some borrowers may be buying a property where they want to use their savings to do substantial remodeling of the property, and the zero-down option will allow the purchase. The borrower may refinance at a lower LTV (based on appraisal) after the remodeling. Others, like those in the VA program, are simply taking advantage of a great opportunity.”
Example of the different monthly payments:
If someone buys a $200,000 home with a FICO score above 720 with a 30-year loan at a fixed rate of 4.40 percent, the monthly payments for interest and principal would be:
- Zero down: $1,001.52
- 10% down: $901.37
- 20% down: $801.22
Highfield says it should be noted these payment amounts do not adjust for the possibility that the lower downpayment options may have a higher interest rate associated with them. So, the monthly cost of a lower down payment may be understated in the example figures above.
No-downpayment loans may add mortgage insurance
Private mortgage insurance is an annual fee, paid monthly, which typically ranges from 0.30% to 1.15% of the outstanding balance of the mortgage, he says. The fee is based on the amount of the downpayment percentage, loan term, and borrower’s credit score. However, as noted earlier, several zero-down programs do not have mortgage insurance premiums (VA, USDA and Navy Federal Credit Union options).
Pros of 100-percent financing:
- Opportunity earned through Service – Highfield says some buyers should take advantage of special government programs like VA, USDA and more.
- Maintain flexibility – Buyers who withhold cash reserves can use those funds for remodeling or as a buffer for emergencies.
- Starting a practice – Physicians and others who qualify, can use the program to start their practice and become part of the community they serve.
- Improve life for family – “In some cases, a borrower may take advantage of zero-down program to move out of an unfavorable renting/housing situation even without significant savings,” he explains.
Cons of 100-percent financing:
- Higher monthly payments – Even if the rate is not higher, a zero-down mortgage will typically be more costly on a monthly basis.
- Higher PMI – If the mortgage is subject to mortgage insurance, low downpayments will result in higher premiums.
- Underwater possibilities – “If housing prices fall (such as from 2007-2009), a zero-down loan will quickly go underwater, and the borrower will owe more than the home is worth,” Highfield states. Thus, it will be difficult for them to sell the home if they needed to do so. These individuals also need to be cautious about other debts, as it increases their financial risk.
- Fees – Low downpayment options typically have a funding fee payable to lenders. These fees can be substantial. If they are incorporated into the loan, the buyer will get the keys and owe more than the home is worth.