"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.
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.
So 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.
Comments(18)