Question: I’ve been reading about a new bunch of mortgages with one percent down but now my lender says they’re gone. Where did they go?
Answer: In the eternal search for less down, any mortgage program with a smaller upfront cost always attracts a certain amount of attention.
In part, the reason for the popularity for financing to little upfront and high loan-to-value ratios (LTVs) relates to a widespread inability to save.
It’s been widely reported that almost 70 percent of the population has less than $1,000 in the bank, not enough for a downpayment, let alone a surprise auto repair or a quick trip to the emergency room.
For many potential home buyers, the big barrier to ownership is not the monthly payment or credit score, but the need to find financing with the best possible LTV, 97 percent rather than 95 percent.
At the same time, lenders have discovered that loans with little down have less risk than once thought. According to the Urban Institute, “the default rate for 95 to 97 percent LTV mortgages is only slightly higher than for 90 to 95 LTV mortgages, and the default rate for high FICO loans with 95 to 97 LTV ratios is lower than the default rate for low FICO loans with 90 to 95 percent LTV ratios.”
Given this background, it follows that one way to originate more loans is to come up with programs that require less down – and that brings us to 2014 when Freddie Mac introduced its “Home Possible Advantage” plan, a form of financing which requires just three percent down instead of the usual five percent needed for conforming loans.
It turns out that three percent down – a 97-percent LTV – is better for a lot of buyers than five percent down – a 95-percent LTV. If you want a $200,000 mortgage, the difference is a need to finance with $6,000 down versus $10,000 up-front. For many borrowers, the extra $4,000 is a deal killer. Also, closing costs are on top of the downpayment.
A number of lenders looked at the Freddie Mac program and said, “wait a minute, we can make this a lot more enticing if we can get the downpayment even further down. Let’s give a two percent grant to borrowers.”
If you have a program with a three percent downpayment requirement and knock off two percent, then a borrower only needs one percent for the downpayment. For that $200,000 loan the downpayment is reduced to $4,000.
A “grant” is something you don’t have to repay. How can lenders afford to give such a gift? One idea is to re-coup grants elsewhere in the deal, perhaps in the form of “premium” pricing, steeper fees, or both.
But premium pricing – a higher interest cost, larger fees, or both — presents a problem: If the interest rate is higher in exchange for the grant than the borrower has steeper monthly costs. Bigger monthly payments represent more risk for lenders, investors, and those who insure mortgages.
As of November 1st, Freddie Mac is changing its guidelines and borrowers will have to first come up with three percent down. The three percent down can come from “the Borrower’s personal funds and/or other permitted sources of funds, including a gift from a Related Person, funds from government agencies, employer housing programs and Affordable Seconds.”
Once the borrower has come up with the full three percent downpayment from their own funds, then a lender grant might be acceptable.
You can still get downpayment help from family members, government programs, and employers. What you can’t get is downpayment help from lenders or sellers.