The 20% Down Payment Myth

Question: Is it possible to buy a home with less than 20% down?

Answer: I’m always surprised by the number of people who assume they have to put 20% down to buy a home and delay their goal of becoming a homeowner for years because of it. Studies show that the most common reason people give for not buying a home is that they don’t have enough for a down payment.

In reality, about 1/3 of Arlington buyers purchase a home with less than 20% down and for many buyers, especially first-time home buyers, they’re putting as little as 3-5% down.

Programs For Everybody

For those with good credit, there are popular Conventional Loan programs allowing for as little as 3% down and for those with lower credit scores, FHA Loan programs range from 3.5%-10% down. There are also some exceptional programs available to those with great credit and strong incomes allowing for 10%-15% down at great rates.

Specialty Programs For Military and Doctors

If you are an active-duty or former servicemember you likely know about VA Loans that allow purchases with zero down. Doctors also have access to special loan programs offering great rates with low down payments for large loan amounts.

Mortgage Insurance

Most loans with less than 20% down will include mortgage insurance, which I wrote about here. It will increase your monthly payment and generally represents a higher percentage of your loan amount the less you put down. However, there are options to get rid of the mortgage insurance fees by buying it out or applying for early removal after a couple of years. There are also some programs that do not include mortgage insurance at all.

Impact on Negotiations

Clients often ask me how much a lower down payment will impact their ability to negotiate, so last year I ran the numbers on the impact of different down payments on the percentage buyers were negotiating off the sale price. The results showed that only cash buyers (100% down) and buyers not putting any money down were materially impacted by their down payment, the negotiation leverage was pretty similar for everybody in between.

However, it would be misleading to suggest that down payment percentage doesn’t have any impact. Most sellers will respond more enthusiastically to higher down payments and this comes into play in competitive scenarios (multiple offers), which has become common in Arlington and the surrounding DC Metro neighborhoods. When sellers are choosing between multiple, similar offers, buyers with higher down payments have an advantage.

Buyers can combat the potential negative impact of a lower down payment in multiple offer scenarios by getting a strong pre-approval letter from a reputable local lender, offering to get pre-approved by a lender of the seller’s choosing, increasing the Earnest Money Deposit, or a number of other tweaks to the contract that will be looked at favorably by the seller, without increasing risk to the buyer or increasing the offer price.

Favorite Mortgage Programs

Here’s a link to an article I wrote with some of my favorite mortgage programs and contact information for great lenders who offer them.

If you’d like any additional information or recommendations on lenders or loan programs, don’t hesitate to reach out to me at Eli@EliResidential.com. If you’re thinking about buying a home in Arlington or the surrounding Northern VA/DC Metro neighborhoods, I’d be happy to meet with you to discuss your options.

Question: Do I have to put 20% down to buy a home?

Answer: This is the most common question I’m asked by buyers and there are a surprising number of people who are well-qualified and want to purchase a home, but sit on the sidelines trying to save for a 20% down payment. Over the last 18 months, nearly one third of buyers in Arlington put less than 20% down and most of those people put 10% or less down.

Popular Low-Down Options

  • Conventional loans are available at 3%, 5%, 10% and 15% down
  • FHA loans are available at 3.5% down
  • If you or your spouse are active or former military, you can qualify for a zero-down loan through the VA. I detailed VA loans in this post from May 2016.
  • Typically, if you have a Jumbo Loan (loan amount exceeds $679,650) you are required to put 20% down unless you qualify for one of many preferred mortgage programs available in the market, which I mention in this post from November 2017.

What’s The Downside?

If you use a non-VA loan with less than 20% down you will have to pay Mortgage Insurance (option to pay it off up-front), which is essentially a monthly penalty/fee assessed on top of your mortgage payment that increases the less you put down and the higher your loan amount.

I explain Mortgage Insurance in this post from July 2016, and explain the process for removing these payments in this post from February 2016.

How Much Are Arlingtonians Putting Down?

Below are statistics pulled from the MLS on the amount Arlingtonians put down to purchase homes over the last 18 months.

These numbers are manually entered by the listing agent at the end of the deal and I think that in some cases agents write 0% financed (cash) instead of entering the correct info so it’s my belief that the number of loans with low down payments is actually a bit higher than the statistics reflect.

  • 32% of all purchases were made with less than 20% down, 26% with 10% or less down, and 18% with 5% or less down
  • 39% of townhomes, 37% of condos and 22% of detached/single family homes are purchased with less than 20% down
  • 14% of purchases were not financed (cash)
  • Only 3% of purchases required FHA financing and less than 2% were FHA-financed condo purchases, so consider this if your Condo Association is setting rental caps simply to qualify for FHA financing

Feel free to reach out with any questions you have about your loan options for purchasing a home anywhere in Virginia, Washington, DC or Maryland. I’m happy to answer any specific questions you have or connect you with a lender who specializes in the type of loan you’re looking for. I’m available any time via email at Eli@EliResidential.com.

Question: Are there good loan options available if I don’t have 20% or more to put down?

Answer: There are an abundance of loan products on the market that cater to different professions, down payments and financial circumstances that you should be aware of. “Rate shopping” is easy and moderately effective, but “product shopping” can be much more valuable and something an informed Agent can assist you with. Here are some of my favorite loan programs and the lenders I work with who provide them:

Doctors: Doctor Loan Program from SunTrust: CJ Kemp (cj.kemp@suntrust.com, (301) 651-4189)

The Doctor Loan Program is a residential mortgage loan specifically created for licensed medical professionals to make obtaining mortgage financing easier and more hassle-free. It recognizes the financial toll of medical school and strong, stable future income post-graduation. The rates on these loans are also fantastic.

Eligible Doctors include:

  • Licensed residents/interns/fellows in MD and DO programs
  • Medical doctors
  • Doctors of osteopathy
  • Doctors of dental medicine/surgeons/orthodontics/general dentists (DMD/DDS)
  • Psychiatrist licensed as a medical doctor

Available financing terms include fixed and adjustable rate mortgages for purchases and rate/term & cash out refinances.

  • 0% down up to $750,000 loan amount
  • 5% down up to a $1M loan amount
  • 10% down up to a $1.5M loan amount
  • No mortgage insurance required

Homeowners Buying And Selling: Second Trust/HELOC Program from First Home Mortgage: Jake Ryon (jryon@firsthome.com, (202) 448-0873)

This is a great program for current homeowners who will be buying and selling simultaneously. It allows you to use the future proceeds from your home sale to make a large down payment on your new home, before even putting your current home on the market.

They partner with local banks and credit unions to provide you with a second trust that allows you to put as little 5% down up to nearly a $1,000,000 loan amount. The second trust finances the remaining amount of your down payment (e.g. 15% if you put down 5%).

The HELOC/second trust payment is interest-only, can be paid off any time and can be used like a bridge loan to allow you to purchase a new home without a home-sale contingency and to sell your existing home unrestricted.

Low Down Payment: Mortgage Insurance Payment Eliminator from McLean Mortgage: Troy Toureau (ttoureau@mcleanmortgage.com, (301) 440-4261)

This program enables you to put as little as 3% to 5% down using conventional financing (not FHA) and eliminate the monthly mortgage insurance payment by making a one-time more affordable payment.  This provides multiple benefits including a potential increase in buying power by reducing the Debt-to-Income ratio (lower monthly payment), allowing you to negotiate for the seller to make this payment by rolling it into closing costs, and ensuring that the entire payment is tax deductible (confirm with your tax advisor).

Large Loan Amounts: Non-Confirming Jumbo Loan Program from Wells Fargo: Email me for contact info at Eli@EliResidential.com

It’s not just the Doctors who can find low down payment options without mortgage insurance for high-value (jumbo) loans. Wells Fargo’s “Professionals” Program lets you put 10.01% down on loans from $424,100 up to $1,000,000 without any mortgage insurance and the rates are incredible. They have options for fixed and adjustable mortgages as well. A high credit score and strong income are key factors for qualifying. It’s referred to as the “Professionals” Program because it’s popular amongst high earning, non-medical professionals like lawyers and consultants.

Make The Right Choice

Choosing the right lender is a combination of selecting the program that’s right for you, getting the best market rates, and working with somebody who provides a high level of service. Earlier this year I wrote an article with additional tips for selecting and comparing lenders. If you have any questions about the programs I summarized above, other lending programs like construction and rehab loans, or would like an introduction to one of my preferred lenders please reach out to me at Eli@EliResidential.com.

Question: What is the likelihood that a lender will approve a loan for ~$500,000 for a first time buyer putting 10% down in a condo building that is approaching or over 50 percent units being rented out?

Answer: This question gives me another opportunity to bring in an industry expert: loan officer Jake Ryon of First Home Mortgage (NMLS #993471). Below, Jake debunks the common myth about rental ratios in condo buildings and introduces the factors that actually impact condo loans most frequently.

MYTH: Buyers Can’t Qualify For Condo Loans If More Than 50 percent of Units Are Rented

One of the most common myths that exists in the industry is that buyers cannot get a loan if more than 50 percent of units are being rented out in a condo building.

TRUTH: Most Homeowners Can Qualify For Condo Loans Regardless Of Rental Ratio

The percentage of units rented in a condo building (aka investor ratio or owner occupancy ratio) has no impact on loans for borrowers that are purchasing or refinancing their primary residence or second home.  If the borrow is an investor seeking a conventional loan, the building must have at least 50 percent of the units occupied by owners (not rented).  FHA’s requirement is the same but does not apply to second homes.  While condo associations may elect to self-impose a rental cap, as it stands now with Fannie Mae and Freddie Mac, it currently doesn’t impact borrowers who are purchasing or refinancing their primary residence or second home.

What Does Impact Loans On Condo Buildings?

  1. Commercial/Non-Residential Square Footage: Currently, Fannie and Freddie cap the total commercial/non-residential square footage in a building at 25 percent of the total space, up from 20 percent a few years ago.  Your lender may be able to obtain a project waiver directly from Fannie Mae if the commercial/non-residential square footage exceeds the 25 percent cap.  I was recently able to obtain a waiver for a five unit project that has 38 percent commercial space (in D.C.) because we were able to show it was common in the area, didn’t impact marketability and were able to provide several comps with similar square footage of commercial/non-residential space.
  2. Single Entity Ownership: The maximum number of units owned by one entity can’t exceed 10 percent of the units in the project per Fannie and Freddie guidelines.  If it is a 2-4 unit project (rare in Arlington, very common in DC), no entity can own more than one unit.  Both Fannie and Freddie do allow one entity to own two units in a project with 5-20 units.  A project waiver may be possible from Fannie Mae if a single entity owns greater than 10 percent.
  3. Delinquency: Fannie and Freddie do not allow more than 15 percent of the units in the Association to be > 60 days delinquent on the payment of their monthly assessments for the project to be warrantable (approved for loans).  A project waiver may be possible with Fannie Mae if the delinquency rate is slightly higher than 15 percent.
  4. Budget: Fannie and Freddie require the Association’s current year adopted budget to include a minimum of 10 percent of the annual monthly assessments to go towards the reserve fund.  If the budget does not document the required 10 percent, a current reserve study that supports the Association’s current level of contribution may be acceptable.

If you have any questions about condo warrantability or anything else loan-related, Jake Ryon can be reached at jryon@firsthome.com202-448-0873 or online. He is located at 1015 15th Street NW Suite #375 Washington DC 20005.

Question: We are buying and selling a home simultaneously and our lender has provided us with a few options to qualify for the purchase without making our offer contingent on the sale of our current home. Do you have any tips for choosing which mortgage product is best for us?

Answer: Buying and selling a home at the same time can be a complex transaction logistically and financially. I explored the seller side of home sale contingencies in October, but here I’ll share advice I give buyers who face difficult financing decisions. Tip of the day: it’s not just about getting the lowest interest rate.

Weigh Your Options

Selling your home before making a purchase may afford you the best loan options, but it doesn’t always make sense for buyers:

  • It weakens your negotiation position on pricing (you’ll pay more) and your ability to compete for new listings
  • You weaken your position on the sale side, with more pressure accept an offer quickly
  • For many families with children and/or pets, selling your home while living there is a logistical nightmare

Mortgage Solutions

Certain lenders have a wide range of loan products to help buyers with limited cash reserves for a down payment, but substantial equity in their homes, qualify for a home purchase without a home sale contingency. The options include a Home Equity Line of Credit (HELOC), a second trust loan in which a large portion of your down payment comes from a second interest-only loan, and bridge loans (less common). Each of these options come with different short and long-term costs, so it can be difficult to decide what is best for you and your family.

Get A Professional Opinion

Most real estate transactions involve three professionals – your agent, your lender, and your title company, but when you’re faced with complex financial decisions, I highly recommend using a Financial Consultant to help you determine which financing option suits you. Your lender can explain the cost, pros/cons, and time constraints of each loan option and your agent can explain how different types of loans and contingencies will impact your transaction, but a good Financial Consultant will be able to help you determine the best way to leverage cash, debt, and tax write-offs to maximize your financial position.

Financial Consultants should do more than help you pick mutual funds for your retirement accounts and act as an expert sounding board when you’re facing major life decisions, like how to finance your home purchase. They can build models and run scenarios within the context of your personal savings/investment plan to help you make your decision. Although an experienced advisor can provide great advice with limited knowledge of your personal finances, you’ll get the most from somebody who has a complete picture of your finances and goals, so engage a professional early, if you haven’t already.

If you’re looking for a recommendation, Carl Grund (CFP, CPWA, AIF) with Signature Financial Parners has helped multiple clients of mine with difficult real estate decisions and is a local Arlingtonian. Feel free to contact him at cgrund@sfpfinancial.com or 703-287-7128 for immediate or future advice.

Question: Does it matter which lender/mortgage company I choose when I purchase a home?

Answer: Choosing a good lender is one of the most important decisions you make during the home buying process. One of the initial differentiators is whether your lender runs credit and collects your documents up-front (W-2s, income verification, bank statements, etc) or just asks questions about your income and debt. This early effort drives most of the following reasons a good lender is able to make such a big difference:

Stronger Offers

Better Pre-Approval: When I review offers on a listing, I put a lot of value in the quality of the lender who wrote the pre-approval letter for the buyer. I also call the lender to 1) make sure they’re responsive 2) ask them what information/documents they reviewed and 3) about the financial strength of the buyer. Approval letters from unreliable lenders or lenders who haven’t reviewed a full set of documents pose a moderate risk of not closing, which weakens the offer.

Close Faster: Online lenders and larger banks have difficulty closing in less than 35-45 days, but a good lender can close in less than three weeks. If you find yourself competing for a property, working with a lender who can close faster than the offers you’re competing against will significantly increase the probability of your offer being chosen. I’ve represented buyers and sellers where the chosen offer isn’t the highest sale price, but the strongest overall offer, often attributed to the quality of the lender and their ability to close faster.

Don’t Miss Settlement

Good lenders do not miss the settlement date. Their reputation and business rely on it. If you miss the contracted settlement date, you’re (usually) in default and expose yourself to risks including loss of Earnest Money Deposit or having the contract voided by the seller.

A good question to ask your lender is where their staff works. There are quite a few people involved in getting your loan approved including the loan officer, processor, and underwriters. Lenders with a history of missing settlement deadlines often have staff working in different locations, that don’t regularly work together. If your lender works in the same physical office as all of those people, that’s a good indication that they can handle issues efficiently and have a high probability of meeting the settlement date.

Don’t Get Duped (Rate vs APR)

Be careful when you’re comparing interest rates, especially online rates. First, make sure you’re comparing the Annual Percentage Rate (APR), not the interest rate. Many lenders advertise lower rates by including points (you pay cash up-front for a lower rate) or they charge higher fees. The APR is a measure of the total cost of the loan, including points, fees, and interest rate and allows for an apples-to-apples comparison. Second, it’s important to note that conforming loans (loan amounts of $636,150 or less), which are backed by Fannie Mae and Freddie Mac, typically have very little variation in rates because they usually follow similar Fannie and Freddie guidelines and market pricing. The biggest differences in rates are on non-conforming loan amounts (over $636,150) and in special programs like Doctor or Attorney loans.

Reliable Pre-Approvals

A reliable pre-approval gives you the confidence that you’ll qualify for the loan you’re applying for. Weak pre-approval letters lead to surprises during the loan application process, which can lead to rejection letters or delays. The last thing you want is to find out you don’t qualify after you’ve spent money on a home inspection, appraisal, and started packing for a move that may not happen. Reviewing all of your documents early also gives you and your lender time to fix credit scores, debt ratios, and other issues to increase your purchasing power or improve your interest rates.

Loan Consultant

In most cases, buyers should be considering multiple loan products and finding the best fit. This is particularly true if you’re buying and selling a property and would like to purchase without a home sale contingency, if you’re exploring low down payment options, or if you’re planning to own the property for less than 10 years and can benefit from the lower rates of an Adjustable Rate Mortgage (ARM). A good lender will have access to a wide range of great products, including Doctor and Attorney programs, and be able to advise you on the type of loan that nets you the best long-term results.

If you’re considering buying or in the process of talking to lenders, I’d be happy to make some recommendations based on your financial situation, type of purchase, and goals. Feel free to reach out to me at Eli@RealtyDCMetro.com.

Question: If I purchase an as-is home to renovate myself, what are the best financing options available to me?

Answer: This is Part 2 of the question I answered last week about buying a home as-is. I asked one of the area’s top lenders, Troy Toureau of McLean Mortgage to provide a detailed response. Troy is a fantastic resource for any of your mortgage questions/needs. The following is his response:

If you want to own a home in Arlington or other areas surrounding the city, there is a lot of competition. The good news is that there are older homes requiring updates that many home buyers ignore, while newer, higher-priced properties often attract multiple offers.

Focusing on the renovation-ready market can expand your choices and perhaps give you access to a better location. The process of renovating can also give you a home that is more custom-tailored to your tastes and needs.

Financing a home that you will renovate is a bit more complex than a standard purchase loan. The good news is that there are several options that will help you achieve your goals of upgrading and/or customizing the house for your needs:

Construction Loans

If your renovations are projected to cost over $100,000, you can opt for a construction-permanent loan, based on the value of the home after the renovations are completed. Here is an example:

  • Purchase Price: $450,000
  • Renovation Budget: $150,000

In this case, your total needs are $600,000 and you can obtain a loan of up to 95% of that amount. You will receive the money at closing for the purchase, and then the remainder of the money in draws paid directly to the construction company as the work is completed. When the work is done, you do not have to finance the home again, as this “one-time-close” construction loan will automatically convert to a permanent loan. Larger down payments will be needed for larger loan amounts. Note that there are additional costs associated with construction loans because the appraisal is more complex and there are costs for periodic inspections and draws.

As an additional option, you can opt for a traditional construction loan and refinance into a permanent loan after the work is complete. While this will result in more costs by adding a refinance transaction, you will have more choices for permanent financing on the back end.

Other Financing Options

For renovations under $100,000, there are two good strategies:

  • If you are planning to put 20% or more down on a $600,000 loan, you can simply reduce your down payment to 10%, or even 5%, conserving your cash for the renovations. Here is an example:
    • $600,000 Purchase Price with 20% Down: $120,000
    • $600,000 Purchase Price with 5% Down: $30,000
    • Available funds for renovations: $90,000
    • In addition, the renovations may give you a higher appraised value to help eliminate the mortgage insurance costs associated with lower down payments.
  • If you do not have the cash assets for a large down payment, you can close on the property and then obtain a second mortgage or home equity line-of-credit (HELOC) after closing. To do this, you’ll need to find a bank that will lend the money based upon the renovated value of the house.

In today’s real estate market, especially in high-demand areas, it pays to explore all of your options. If you would like to discuss some of these options when you are considering purchasing a new home and/or renovating an existing home, feel free to contact me at ttoureau@mcleanmortgage.com or (301) 440-4261.

Troy Toureau, Vice President of Production, NMLS #5618
www.AnyHomeLoans.com | 11325 Random Hills Road, Suite 400, Fairfax, VA 22030
McLean Mortgage Corporation | NMLS #99665 (www.nmlsconsumeraccess.org) Equal Housing Lender

Question: Are there any special loan programs in Arlington or Virginia that I should look into?

Answer: The Virginia Housing Development Authority (VHDA) offers a great loan program that includes closing cost and down payment assistance. There aren’t any Arlington-specific loan programs available, but some special programs are made available based on your income and sale price based on the local (Arlington) averages, which are both high. There is a specific Arlington Housing Grant Program available for those who qualify and I’m happy to send additional information on this program if you are interested, but there are too many caveats/requirements to provide specifics here.

As usual, when I get financing questions, I like to turn to one of Northern Virginia’s top lenders, Troy Toureau of McLean Mortgage, to provide a detailed response.

Take it away Troy…

Despite the many changes in home financing which have occurred during the past decade, one important fact has never changed:  The government has several programs to help buyers purchase a home. Here is a quick summary of the major “government sponsored” home financing alternatives. 

The Virginia Housing Development Authority

Authorized by the Federal Bond Subsidy Act, this state agency issues bonds, which enables it to offer below market interest rates and government down payment assistance on mortgages.  VHDA offers several programs and most recently has issued a Grant program, which can help with closing costs and a down payment.  The VHDA can also issue Mortgage Credit Certificates, which will help defray the cost of the payment by providing a tax credit for a certain amount of interest paid.

VHDA requires that the homebuyer has not owned a home in the past three years and also has maximum income and asset limits. For those purchasing in certain targeted areas, there is flexibility with regard to these restrictions.   The income limits in the Washington, DC area are $121,900 (2-person families) or $142,300 (3+ person families) and the sales price limit is $500,000. There are some targeted areas in Arlington County and if you are interested in knowing whether a property is in a targeted area, emailttoureau@mcleanmortgage.com.

In addition to the VHDA Grant program, VHDA provides a variety of options to help first time buyers finance a home.  These include VHDA loans guaranteed by Virginia and insured by the Rural Housing Service requiring no-money down.  The VHDA FHA-Plus Program provides a second mortgage for those who need closing cost and down payment assistance and the conventional VHDA alternative requires a down payment of only 3.0% with private mortgage insurance.  Keep in mind that the three-year history, income, and asset limits noted above still apply.

The Veterans Administration (VA)

VA loans require no down payment and no monthly mortgage insurance.  Closing costs can be paid by the seller or through a lender rebate. The homebuyer must be a veteran or active military.  National Guardsman and Reservists are also eligible for the program. There is no requirement for the veteran to be a first time homebuyer and no maximum income or asset requirements. 

The Federal Housing Administration (FHA)

FHA loans require a 3.5% down payment, which can be met with grants through VHDA or other housing agencies, if available. FHA also allows the down payment to come from a gift from a relative and closing costs can be paid by the seller or through a lender rebate.  There is no requirement for the applicant to be a first time homebuyer and no maximum income or asset requirements. 

Fannie Mae and Freddie Mac

The conforming agencies both have programs designed to facilitate homeownership for low-to-moderate homebuyers. The requirements vary depending upon the agency, but generally a 3.0% down payment is required and there are maximum income requirements that vary by location. Credit score requirements tend to be slightly more restrictive under these programs, as compared to FHA and VA Loans.

Government aid for home ownership does not end with these programs.  Homeowners of primary residences can deduct interest and real estate taxes from the taxes. This lowers their taxable income and thus their effective housing payment.  We suggest you consult with an accountant or financial advisor to discuss all of the tax benefits of home ownership.

If you would like to know if you qualify for one or more of the government sponsored homeownership alternatives, contact Troy Toureau of McLean Mortgage Corporation at301-440-4261 or ttoureau@mcleanmortgage.com.  NMLS ID #5618.  McLean Mortgage Corporation| NMLS ID #99665|(www.nmlsconsumeraccess.org)

Question: I haven’t accumulated enough savings for a 20% down payment, but want to take advantage of low interest rates and stop paying rent. I’ve been told that some of the lower down payment mortgage options include Mortgage Insurance, but don’t fully understand the concept and whether it’s the right decision. Can you provide some insight and explain the pros/cons?

I’ve received a few questions over the past month about mortgage insurance and decided to enlist the expertise of a veteran mortgage advisor, Troy Toureau of McLean Mortgage for this week’s column.

What is mortgage insurance?

Mortgage insurance is offered by either the government or private insurance companies to enable lenders to offer smaller down payments on loans. Before mortgage insurance existed, many had to pay a minimum of 20% down to purchase a home, which made homeownership unaffordable for many Americans. Mortgage insurance covers lenders for losses up to a certain amount if a borrower defaults on their mortgage.

There are two types of mortgage insurance available:

  1. FHA mortgage insurance: FHA is a government program, which requires a down payment of as little as 3.5% of the sales price, and mortgage insurance is required on FHA mortgages, regardless of the amount of down payment.
  2. Conventional mortgage insurance: Conventional mortgages are home loans that are not insured or guaranteed by the government, as in the case of the FHA mortgage example. Many conventional loans are sold to Fannie Mae or Freddie Mac and thus follow these entities “conforming” guidelines.

Conventional or private mortgage insurance enables lenders to offer conventional loans with a minimum down payment of 3.0% to 5.0%. Most 3.0% down conventional mortgages are restricted to low-to-moderate income borrowers.

What is the cost of mortgage insurance?

The cost of mortgage insurance will vary greatly, depending upon several factors:

  1. The mortgage insurance alternative selected
  2. The amount of the down payment
  3. The type of the mortgage such as a 30-year or 15-year loan
  4. The qualifications of the borrower, especially the credit score
  5. Whether the mortgage is an FHA or conventional loan

In addition, depending upon the alternative selected, the cost of mortgage insurance can be an upfront fee, an additional monthly payment, or financed into the loan amount or interest rate. Or the cost may be represented by some combination of these alternatives.

 

What are the alternatives and the advantages of each?

There are a wide variety of mortgage insurance alternatives. In this case we’ll compare two major alternatives. Conventional mortgage insurance paid monthly and conventional mortgage insurance in which the cost of insurance is paid through a higher interest rate.

These examples are for illustration only:

Monthly example: $300,000, mortgage insurance rate of .40%. The monthly payment would be $100.00 per month.

Higher interest rate example: $300,000 mortgage and 0.375% added to the interest rate: approximately $65.00 per month in additional payment monthly.

At first blush, opting for a higher interest rate in this case would be the best option. However, there are other factors involved:

  • In both cases the interest on the mortgage or the separate mortgage insurance payment is likely to be tax deductible. However, if your income is higher than $110,000 annually, the monthly mortgage insurance payment may not be deducted from your taxes. In addition, the deduction of separate mortgage insurance payments is extended on a year-to-year basis by Congress and thus has not been made permanent.
  • Monthly mortgage insurance can be cancelled after a certain period of time with some restrictions such as keeping current on your payments. The payment can be cancelled:
    • When the loan reaches 80% of original sales price based upon regular amortization (the lender must do so automatically when it reaches 78%); or
    • When the loan reaches 75% of the present value of the property and two years of payments have been made; or
    • When the loan reaches 80% of the present value of the property and five years of payments have been made.
    • If the loan is an FHA loan, mortgage insurance can never be cancelled unless a 10% down payment was made at the time of purchase.

This means that if the home was purchased below market value, significant improvements are made to the home, or if the owner is going to pre-pay the mortgage, one may have to pay the monthly mortgage insurance payment for as little as two years before cancelling it. When you roll the mortgage insurance cost into the interest rate, you would have to pay until the loan is paid off in the long-term or the home is sold or the loan is refinanced.

Can I avoid mortgage insurance and still make a low down payment?

There are options to eliminate mortgage insurance altogether by getting a second mortgage on the property. Here is an example:

  • $400,000 sales price, 10% down payment, $360,000 mortgage with mortgage insurance.
  • $400,000 sales price, 10% down payment, $320,000 first mortgage with a $40,000 second mortgage and no mortgage insurance.

Like the choice of mortgage insurance options, there are advantages and disadvantages with both alternatives, besides the difference in payments. For example, while the mortgage payment is more likely to be tax-deductible under the first and second mortgage scenario, you must pay on a second mortgage until it is paid off or is refinanced, while the mortgage insurance may be cancellable in the future.

In addition, the second mortgage is likely to be at a higher interest rate as compared to the first mortgage and also could either be amortized over 15-years requiring a higher payment, or an adjustable rate mortgage whose rate may change in the future. Thus, the home purchaser must consider additional benefits and costs besides the difference in payments.

The decision of whether to pay mortgage insurance or not and what alternatives to choose is complex and will change based upon the situation, including the qualifications of the buyer and the nature of the transaction. That is why it is so important to obtain the advice of an expert mortgage advisor before you purchase a home.

Thank you Troy for answering this week’s question. If you’d like to discuss mortgage insurance or any other mortgage strategies with Troy, he can be reached atttoureau@mcleanmortgage.com or on his cell at (301) 440-4261.

Troy Toureau, Vice President of Production, NMLS #5618
www.AnyHomeLoans.com | 11325 Random Hills Road, Fairfax, VA 22030
McLean Mortgage Corporation | NMLS #99665 (www.nmlsconsumeraccess.org) Equal Housing Lender

If you’d like a question answered in my weekly column, please send an email toEli@RealtyDCMetro.com. To read any of my older posts, visit the blog section of my website at http://www.RealtyDCMetro.com.

Eli Tucker is a licensed Realtor in Virginia, Washington DC, and Maryland with Real Living At Home, 2420 Wilson Blvd #101 Arlington, VA 22201, (202) 518-8781.

Question: Are funding fees on VA loans eligible for seller credits?

Loans guaranteed by the Department of Veterans Affairs are known as VA Loans (Who thought VA stood for Virginia? Be honest…) and provide current and former servicemembers with an opportunity to purchase a home with as little as 0% down. In addition to the normal closing costs (title fees, transfer taxes, etc), a Funding Fee is charged at settlement, which is equal to anywhere from 1.5-3.3% of the loan amount. It’s a fee paid to the VA on every loan to offset the cost of loans that default. It’s the same concept as Mortgage Insurance, but much cheaper.

In a previous column, I explained how buyers can negotiate for seller credits to reduce or eliminate the out-of-pocket expense of closing costs at settlement. Fortunately, the Funding Fee falls into this category, along with the rest of the standard closing costs associated with a VA loan, and buyers are eligible to have all of these costs covered by the seller. In theory, if a buyer is able to negotiate 100% of closing costs paid by the seller and chooses a 0% down payment loan, a home can be purchased cash-free (until the first monthly payment).

If you’re unable to negotiate seller credits to cover the Funding Fee and are concerned about having the cash to pay for closing costs, you’re also allowed to roll the Funding Fee into your mortgage so that it becomes part of your monthly payment.

Arlington Veterans Affairs (VA) loans by the numbers:

  • In 2015, 218 of 2,893 purchasers (7.5%) used a VA loan. By comparison, 2,038 used a Conventional loan (70%). I’m actually a little surprised by this; I would’ve thought a higher percentage of purchases in Arlington would use VA loans.
  • The average sold price for homes purchased using VA loans was just over $581,000
  • The type of housing purchased using VA loans was pretty evenly split between single family (detached), townhouse, and condo
  • The maximum loan amount for Arlington (and the rest of the Northern VA counties) is $625,500, but there are ways to increase the loan amount by putting more money down.

I hope the veterans and active duty military residents of Arlington had a great Memorial Day Weekend. Thank you for your service!