Contemporary Financial Services, Inc.

What are low down payment options, for buyers who can't afford a 20% down payment?

Assuming you can afford (and qualify for) high monthly mortgage payments and have a high credit score, you should be able to find a low (5% to 15%) or even no down payment loan. However, you may have to pay a higher interest rate and loan fees (points) than someone making a larger down payment.
If you put down less than 20%, you may have to either pay for private mortgage insurance (PMI) or, to avoid PMI, take out two separate loans (a first mortgage and a second mortgage).

Private mortgage insurance or "PMI" policies are designed to reimburse a mortgage lender up to a certain amount if you default on your loan and your house isn't worth enough to entirely repay the lender through a foreclosure sale. Most lenders require PMI on loans where the borrower makes a down payment of less than 20%.

Premiums are usually paid monthly and typically cost around one-half of one percent of the mortgage loan. You can normally cancel the PMI once your equity in the house reaches 20-25%, so long as you've made timely mortgage payments

Save money by asking your mortgage company to cancel your private mortgage insurance (PMI).

Private mortgage insurance (PMI) protects the lender should you default on your mortgage payments, and is often required for loans where the down payment is less than 15 to 20%. It is added on to your mortgage payment each month. PMI can usually be canceled after your home's value has risen enough to give you 20 to 25% equity in your house.

Start trying to get your PMI cancelled as soon as you suspect that your equity in your home or its value has gone up significantly. The most obvious way for equity to increase is because you’ve made a lot of mortgage payments. Your equity may also increase because your home’s value has gone up due to a rise in local home values or because you’ve remodeled. Such value-based rises in equity are harder to prove to your lender, and some lenders require you to wait a minimum time (around two years) before they will approve cancellation of PMI on this basis.

Did you choose to pay a higher interest rate on your mortgage in order to avoid PMI premiums? If so, don’t expect your lender to lower your payments after your equity has increased. Your interest rate is permanent, even if the lender used the extra money to purchase PMI to cover your loan. Your best course of action is probably to refinance.

The exact rules for canceling PMI are largely in the hands of your lender -- or, to be more accurate, in the hands of the company from whom your lender buys mortgage insurance (though you’ll never deal with the insurance company directly).

Let's start with the IRAs. Under the 1997 Taxpayer Relief Act, certain homeowners can withdraw up to $10,000 penalty free from an individual retirement account (IRA) for a down payment to purchase a principal residence (though you might have to pay income tax on the amount withdrawn). If you've got a Roth IRA, however, you must have had the account for five years to make tax-free withdrawals.

This $10,000 is a lifetime limit -- and the money must be used within 120 days of the date you receive it. The law limits use of this benefit to so-called "first-time homeowners" -- but generously defines these as people who haven't owned a house for the past two years. If a couple is buying a home, both must be first-time homeowners. Ask your tax accountant for more information, or check IRS rules at www.irs.gov

If you have a 401(k), you have two options. One is to do a so-called hardship withdrawal -- but, because this would subject you to taxes and a 10% penalty, we recommend you avoid this.
You can also take an ordinary loan from your 401(k) plan without penalty, as long as meet certain conditions and you promise to pay it back. Borrowing against your 401(k) offers several advantages:

Keep in mind, however, that you'll need to repay the loan with after-tax dollars, and you'll forego the earnings on the 401(k) money you withdraw -- until it is paid back.

Ask your employer or plan administrator whether your plan allows loans. If it does, the maximum loan amount under the law is one-half of your vested balance in the plan, or $50,000, whichever is less. (If, however, you have less than $20,000 in your plan, your limit is the amount of your vested balance, but no more than $10,000.) Other conditions, including the maximum term, the minimum loan amount, the interest rate, and the applicable loan fees, are set by your employer. Any loan must be repaid in a "reasonable amount of time," although the Tax Code doesn't define what is reasonable.

Be sure to find out what happens if you leave your job before fully repaying a loan from your 401(k) plan. If a loan becomes due immediately on your departure, income tax penalties may apply to the outstanding balance -- but you may be able to avoid this hassle by repaying the loan before you leave the job.

Several federal, state, and local government financing programs are available to homebuyers. The two main federal programs are:

VA loans. U.S. Department of Veterans Affairs (VA) loans are available to men and women who are now in the military and to veterans with honorable discharges who meet specific eligibility rules, most of which relate to length of service. The VA doesn't make mortgage loans, but guarantees part of the house loan you get from a bank, savings and loan, or other private lender. If you default, the VA pays the lender the amount guaranteed and you in turn will owe the VA. This guarantee makes it easier for veterans to get favorable loan terms with a low down payment. For more information, check the VA's Website at www.va.gov or contact a regional VA office for advice.

FHA loans. The Federal Housing Administration (FHA), an agency of the Department of Housing and Urban Development (HUD), insures loans made to all U.S. citizens, permanent residents, and noncitizens with work permits who meet financial qualification rules. Under its most popular program, if the buyer defaults and the lender forecloses, the FHA pays 100% of the amount insured. This loan insurance lets qualified people buy affordable houses. The major attraction of an FHA-insured loan is that it requires a low down payment, usually about 3% to 5%. For more information on FHA loan programs, contact a regional office of HUD or check the FHA website at www.hud.gov.

For information on other government loans, contact your state and local housing offices. They often have programs available for first-time homebuyers who are purchasing modestly priced properties. To find your state housing office, check the State and Local Government on the Net Directory at https://statelocalgov.net. Or, go to your state's home page, where you may find the listing for your state's housing office.

With a fixed rate mortgage, the interest rate and the amount you pay each month remain the same over the entire mortgage term, traditionally 15 or 30 years. A number of variations are available, including five- and seven-year fixed rate loans with balloon payments at the end.

With an adjustable rate mortgage (ARM), the interest rate fluctuates according to the interest rates in the economy. Initial interest rates of ARMs are typically offered at a discounted ("teaser") interest rate that is lower than the rate for fixed rate mortgages. Over time, when initial discounts are filtered out, ARM rates will fluctuate as general interest rates go up and down. Different ARMs are tied to different financial indexes, some of which fluctuate up or down more quickly than others. To avoid constant and drastic changes, ARMs typically regulate (cap) how much and how often the interest rate and/or payments can change in a year and over the life of the loan. A number of variations are available for adjustable rate mortgages, including hybrids that change from a fixed to an adjustable rate after a period of years, or "option ARMs" that allow you to choose, on a monthly basis, whether to pay a minimum amount, an interest-only amount, an ordinary principal plus interest amount, or an accelerated payment amount.

It depends. Because interest rates and mortgage options change often, your choice of a fixed or adjustable rate mortgage should depend on:

The interest rates and mortgage options available when you're buying a house
Your view of the future (generally, high inflation will mean ARM rates will go up and lower inflation means that they will fall)
Your personal financial and investment goals, and
How willing you are to take a risk.

When mortgage rates are low, a fixed rate mortgage is the best bet for many buyers. Over the next five, ten, or thirty years, interest rates are more apt to go up than further down. Even if rates could go a little lower in the short run, an ARMs teaser rate will adjust up soon and you won't gain much if you plan to stay in the house more than a few years. In the long run, ARMs are likely to go up, meaning many buyers will be best off locking in a favorable fixed rate now and not taking the risk of much higher rates later.

Keep in mind that lenders not only lend money to purchase homes; they also lend money to refinance homes. For example, if you take out a fixed rate loan now, and several years from now interest rates have dropped, refinancing will probably be an option.

There are several downsides to refinancing. Unless you can negotiate a low-cost refi, you may have to pay the same fees and points as for an original mortgage. This means you may reduce your monthly payment right away but not actually begin to save money on the refi for several years. So, if you think you will be moving again soon, it may not make sense to refinance.

How do I find the least costly mortgage? Does it make sense to pay more points for a lower interest rate?

You can save real money if you carefully shop for a mortgage. Everything else being equal, even a one-quarter percentage point difference in interest rates can mean savings of thousands of dollars over the life of a mortgage.

A popular option recently has been "interest-only" loans, which allow you to pay only the interest amount each month -- not any principal -- for the first ten years of the loan. This can lower your initial monthly payments significantly, allowing you to afford more house. Most interest-only loans are adjustable, but it's possible to find fixed rate interest-only loans too.
In addition to comparing interest rates, there are many types of fees -- and fee amounts -- associated with getting a mortgage, including loan application fees, credit check fees, private mortgage insurance (if you're making a low down payment), and points.

Points comprise the largest part of lender fees, so it's important to understand how they work: One point is 1% of the loan principal. Thus, your fee for borrowing $250,000 at two points is $5,000. There is normally a direct relationship between the number of points lenders charge and the interest rates they quote for the same type of mortgage, such as a fixed rate. The more points you pay, the lower your rate of interest, and vice versa.

Before comparing points to interest, factor in how long you plan to own your house. The longer you live in your house (or pay on the mortgage), the better off you'll be paying more points up front in return for a lower interest rate. On the other hand, if you think you'll sell or refinance your house within two or three years, we strongly recommend that you obtain a loan with as few points as possible.
Our mortgage planners can walk you through all options and tradeoffs such as higher fees or points for a lower interest rate.