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Zero Down Mortgage Loans

By
Mortgage and Lending with Arizona Wholesale Mortgage Inc.

empty pockets, no money for down payment"Zero down" or "no money down" mortgages have become increasingly popular as of late.  Especially in the past five years or so, as banks have become just plain aggressive about financing "zero down" borrowers - once considered far too risky.

This article will be lengthy and boring if I discuss the whos and the why's, so let us simply look at three types of zero down mortgages.

First Disclaimer:  Today, I will cover three types of zero-down loans.  There are more, but these are the most popular and common.

I will put them in order from my favorite to my least favorite.  I will list the pros and cons of each.

1.  The 103% mortgage- one loan, with monthly mortgage insurance (PMI).  This is my favorite.  This loan allows the mortgage loan amount to be 103% of the cost of the home.  That is to say that if the contracted price of the home is $200,000- the borrower can borrower $206,000 so that he or she may take care of closing costs, a roof repair necessary for close of escrow, or anything else necessary to the transaction. 

Because my mortgage company works at a discounted fee structure, we rarely borrow the full 103% (unless the borrower wants to buy down the rate).  Our clients tend to borrow 101% - 102% when offered this loan. 

Cons:  One "bad" thing about this loan is that you must have very good credit-- which makes sense of course. 

If you don't have very good credit, you can also get this loan if you are a teacher, policeman, or fireman.  These are "Community Heroes" and so underwriting is a a very loose for them, as they deserve.  (There may be another hero or two recently added to that list, so contact me if you want to be kept in the loop.)

Another "negative" is that the Mortgage insurance (PMI) is expensive on a 103% loan!  However, if your home appreciates at 7% per year, in about 3-and-a-half years, you can have your home appraised and have that dreaded PMI dropped.  Important to understand:  Once you have 20% equity in the house, it is up to you to contact the bank and let them know this and provide them with an appraisal.  Otherwise, you'll throw thousands of dollars away in unecessary insurance (PMI).  The bank won't contact you until you actually pay your home down 20%- which takes a lot longer than appreciation.gift box filled with down payment money

2.  You can get an FHA Loan and have the seller of the home "gift back" your down payment (and even closing costs if you want).  Okay, I've heard this explained with extremely complex verbiage, but it really isn't as confusing as some peole would have you believe.

Let's keep the math simple:  You find a house for $100,000 and you decide you want it.  You ask the seller if he or she will take $95,000 for it and the seller says "yes".  However, the contract is still written up as a $100,000 sale, with an addendum that states that the seller will contribute $5000 to the buyer at close of escrow.  The seller gets the $95K they wanted and you were gifted your down payment and closing costs.  Bam, that simple.

Cons: FHA loans have limits, depending on where you live.  Check them out right here.  Also, it doesn't matter if your home doubles in price in one year, you still have to pay mortgage insurance on an FHA loan until you have paid down 20% in equity. 

3.  The "80/20" Scam.  Okay, it's not really a "scam" per se...but I don't like these loans.  You see, if you have less than 20% equity in your home (a 20% down payment), you are required to purchase mortgage insurance to protect the bank in case you foreclose.  People don't like mortgage insurance because they don't see how it directly benefits them.  I would say some people are even downright bitter about it.  However, without mortgage insurance, most people in the United States would not be able to buy a home.  Mortgage Insurance allows the once-unqualified borrower to have PMI stand behind him or her and say, "I got your back."

Yet still, people resent it!

Banks are clever though.  People don't like mortgage insurance?  No problem!  We'll find a way that will make them happy and make us more money...

So they started advertising the "Zero-Down, 80/20, with no mortgage insurance."  How generous.

You take out a first mortgage for 80% of the value of the home.  There is a "hit" to the rate for having "secondary financing" however.  So if normal 30-year fixed rates are at 6.00% that day, you'll probably pay 6.25% for your first mortgage- the 80% portion of your 80/20.

Next, you take out a second mortgage to cover the remaining 20%.  How nice this bank is being to help you like this!  Of course, as you know, a second mortgage is riskier to any bank, since it holds "second lien position" and-- in a foreclosure or catastrophe-- the second mortgage can only be satisfied after the first mortgage is paid in full.

shocked boy, paid too much for PMISo the rates on second mortgages are higher, of course.

Most of them are based on "prime" which is at 8.75% as I write this, but has no cap.  They adjust monthly.  (These are typically called HELOCS or lines of credit.)  If you are lucky, you will find a lender that has a fixed rate second.  The interest rate on a fixed-rate second mortgage will also be 8-point-something, but at least it doesn't adjust.

The lender explains to you that the mortgage insurance would have cost you $150 per month, but this 80/20, even considering its inflated interest rates, only costs you an extra $75 per month!  You are saving $75 per month over those suckers who pay PMI!

What the loan officer does not tell you is that you are stuck with that crappy second mortgage for the next 30 years!  The guy who took 6% (with PMI, from example one)...well, his PMI was dropped years ago and his payment has been lower than yours since then.  Of course, you could always refinance and roll both of your loans into one PMI-free loan.  But than, of course, you will incure all of the costs of that refinance and you can tack that onto your so-called "savings."  You've just been taken for a ride.

With banks, please try to remember:  A.) They are not your friends B.) If it sounds too good to be true, it probably is.

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Comments(18)

Brian Brady
Matthews Capital Markets - Tampa, FL
858-699-4590

Thanks for the entry in The "Carnival of the Economics of Real Estate".  I'll be posting the entries and winners by Friday and will be sure to notify the winner about his/her new Forbes subscription.  We had fifteen entries; two from new Active Rain members.  You can see all the entries here with a star next to them.

Each entry was masterful.  One person will win the Forbes subscription but all of you won something from your well thought out posts; increased knowledge.  Be sure to comment on each other's posts.  There is a lot to learn from each other.

Feb 28, 2007 04:23 PM
Sharon Simms
Coastal Properties Group International - Christie's International - Saint Petersburg, FL
St. Petersburg FL - CRS CIPS CLHMS RSPS
The other 80/20 scam that really annoys me is when the lender tells the buyer that this loan is based on a 10% or 20% "contribution" from the Seller.
Feb 28, 2007 10:59 PM
Robert D. Ashby
Cruise Planners of South Florida - Plantation, FL
Providing Personalized Travel

Karen,

I like the post and it highlights some good programs (I don't do FHA myself), however I must say I do not agree with all that you said.

I would not call the 80/20 a scam by any means.  It is actually a very good way to secure financing and makes better sense than PMI for many borrowers, even with PMI now being tax deductible.

Let me use a recent example as to why.  I just closed a couple in an 80/20.  Their rates were 6.375% (Interest-Only) on the first and 7.375% on the second (fixed rate).  Hardly the 8% you talked about.  Yes, they had good credit which helps. 

So why did I put them in the 80/20?  The make over $110K AGI, which eliminates the tax deductibility of PMI, so they will receive a lower net cost and significant advantage of the 80/20 over the 100% single loan with PMI.  The savings for them after just 5 years is over $10K. 

The consumer needs to see what products are out there and be shown what is best for them.

Mar 01, 2007 12:07 AM
Maureen Maureen
Orangeburg, NY
Karen - Thanks for the information.  I guess it really pays to shop around for a knowledgeable mortgage agent as well as the lowest rates. 
Mar 01, 2007 07:30 AM
Kaye Thomas
Real Estate West - Manhattan Beach, CA
e-PRO, Manhattan Beach CA

Karen... On 80/20's I'm beginning to think you are right about the PMI Vs the 20% second especially in this market.

As I tell my clients... the bank always wins... that's why they have the money!! 

Mar 01, 2007 06:03 PM
Victor Emeli
The Manor Enterprises - Washington, DC
www.HouseWealthy.com

Karen,

Great points.  The PMI tax deductible thing is a little restrictive right now, since you must make $110k or less.  But it supposedly is only currently valid for 2007.  It must be voted on to be extended passed 07.  We will see if it is extended and if they raise the $110k AGI.

Thanks.

Mar 19, 2007 04:56 AM
Anonymous
Maria

My husband and I are first time home-buyers and we're deciding on what road to take with mortgage type of loan whether the one with the PMI or the 80/20 one. Our realtor suggested the 80/20. My question is, isn't the 80/20 better if you are paying the interest of the 20% and then pay another amount for the principal to make the principal lower  and in time the interest for the 2nd mortgage for the 20% will go down, then I'll be saving money? Or I can't do this because I have to pay the first mortgage first based on the article above?

 Or is PMI better because when our house appreciates and reach an appreciation value of 20% reaching that equity for a 20% downpayt we can actually have the rate of the PMI drop or the whole PMI will be removed completely form our mortgage?

Pls enlighthen. Thank you!

 Maria

Apr 05, 2007 03:40 PM
#7
Anonymous
Maria
Thanks Karen! Are the rules different though when it comes to mortgage since you're in AZ and we're from IL?
Apr 09, 2007 01:46 AM
#8
AZ Mortgage Broker: Michael George
Arizona Wholesale Mortgage Inc. - Phoenix, AZ
AZ Mortgage Rates
Nope.  Not different at all Maria.
Apr 09, 2007 02:02 AM
David A. Podgursky PA
THE PODGURSKY GROUP @ Re/Max Direct - Boynton Beach, FL
THE PODGURSKY GROUP - Make the Right Move!

80/20 scam???

I think PMI vs 80/20 is a matter of cost

if the 20 is Interest Only, then principle reductions can mean a lower payment for the client...

if the PMI + 100% loan is a higher payment, then it will be harder to qualify anyway... and vice versa

I just pick the best scenario for my borrower... now that PMI is tax deductible (for this year) then it isn't as bad a thing - but it isn't a HUGE savings so it should not be factored

Apr 09, 2007 02:39 AM
AZ Mortgage Broker: Michael George
Arizona Wholesale Mortgage Inc. - Phoenix, AZ
AZ Mortgage Rates
That's true David, partly...  I think the PMI is a big savings because you can drop it in three years, but you're stuck with the crappy second forever...unless you refinance and incur all of those nasty costs.  Maybe "scam" is too strong a word.
Apr 09, 2007 03:53 AM
Anonymous
Anonymous

In PMI, in 3 yrs you can drop it provided that the value of your house appreciates and should the appreciation value reach the 20% value of our house when we bought it? Is that correct? As for the 80/20 am I still going to be stuck with it forever even if I pay some of the princiapl amount every month?  One of my friends suggested the 80/20 because if we can pay off a certain amount of the 20% in 2-3 yrs she said we can use it as an equity line to borrow and use it as a downpayt to buy our next house. I'm not sure if that's true. Can I really do that? What are the risks? I think PMI is still better but I'm confused.

 Maria

Apr 09, 2007 09:44 AM
#12
AZ Mortgage Broker: Michael George
Arizona Wholesale Mortgage Inc. - Phoenix, AZ
AZ Mortgage Rates

Your first question, yes correct.

Your second question:  I don't know, you either have an interest-only "20" or an actual loan.  If it's an interest only, than no, you won't be paying it down.

As far as your friend goes:  If you get 1 loan with the lowest rate, you could pay that down the same way and take out a home equity line of credit anytime you want (to buy another home).  But you actually have to be able to afford two house payments.  But this is no reason to take this loan out, because you can always get a line of credit on your house.

 

Apr 09, 2007 09:54 AM
Anonymous
Maria

What's the difference of the "20-interest only" with the "20-actual loan"?

Coz we are planning in the future to buy another house and rent out or sell the old one With this in mind is the PMI still advisable or the 80/20 is better?

Thanks!
 

 

Apr 12, 2007 09:01 AM
#14
Anonymous
Will
I have to disagree with you on the 80/20 being a scam.  As someone already pointed out, it depends on the client's needs.  In our case we were moving to TX which has a high property tax rather than an income tax.  Since we were closing late in the year, we were required to put up 3/4 of a year in taxes up front + 3% down for FHA (seller paid closing costs).  Even though we would get that money back out of escrow after taxes were paid, we simply didn't have the extra several thousand on top of the 3% and moving expenses.  We opted to do a no money down 80/20 with fixed rates on both and use what we did have for down payment to clear our credit debt.  The $400/mo. that we were paying in credit debt has instead been shifted as additional payment to our 20 (it has no prepayment penalty) allowing us to quickly pay off the 20 in 5 years or less and drop it from our monthly payment completely.  Should property values rise faster than we can pay off the 20, we can always refinance both loans into a single (or in our case, we hope to pay off the 20 and then refinance the remainder into a single 15 year).  Obviously not everyone will be fiscally responsible enough to do the same (we have ceased the use of credit cards completely other than paying them off completely each month and instead keep a high line of credit w/ a 0 balance to keep our credit score high), but again it all depends on the client's needs.  Also robbing your investments isn't always a good idea.  Yes, a guaranteed 15% is nice, but only during years like the Clinton dot-com crash of 1999 and the following few years of recession.  The last 2.5 years my investments have made between 20%-30% per year so right now it's good to have that money in the market.
May 03, 2007 07:26 AM
#15
AZ Mortgage Broker: Michael George
Arizona Wholesale Mortgage Inc. - Phoenix, AZ
AZ Mortgage Rates

Will-- In my opinion, you should have done a no-cost, zero-down FHA loan.  You wouldn't have had to come to closing with anything (if you were using a mortgage broker) and you would have a better overall rate.  In addition to that, you wouldn't have to pay the costs of the refinance that you discussed.  Overall, your 80/20 will cost you thousands of dollars more...and how much you had for closing costs is irrelevant.  It sounds like you weren't dealing with the right mortgage company.  I have a client closing an FHA loan today and they are coming in with exactly ZERO DOLLARS for closing and their rate is fixed at 6.25%.  I don't see how anybody could disagree, unless you have been misinformed and it looks like you were.

They made more money off of the 80/20.  The bank did and so did the salesman who didn't offer you a very clean, cost-free FHA loan.  That's too bad.

If you notice, the other mortgage broker that commented that it wasn't a scam, also said he doesn't do FHA loans.  Many brokers just aren't licensed for FHA, so you get the sub-prime 80/20 scam.

May 03, 2007 07:41 AM
Anonymous
Jim Johnson
Great article!  As a real estate broker in Bend Oregon we have started to see more use of FHA loans with the Nehamia program for zero down payment.  http://www.bendoregonrealestateexpert.com/bend-real-estate-blog/
Apr 06, 2008 04:27 AM
#17
Anonymous
zaim ahemad

Thanks for the information. I guess it really pays to shop around for a knowledgeable mortgage agent as well as the lowest rates. I'm beginning to think you are right about the PMI Vs the 20% second especially in this market.Thanks for the side once again

Mar 19, 2009 05:59 PM
#18