No Down Payment Vs Low Down Payment Mortgages
Down payment definition
Down payment is the initial amount a buyer pays toward the purchase of an expensive good or service. Certain items such as cars or home usually require huge amount of cash outlay to buy. It is unusual that many people will not be able to afford hundred per cent payment. For this reason, the seller may allow the buyer to pay a portion of the full amount so that he can take the delivery of the good or service. The balance amount will need to be financed by the seller while the buyer pays back the principal including the interest on instalments. Down payment gives the seller some level of confidence that the buyer will not default in payments. For instance, if you make a down-payment towards the purchase of a home, it means that the balance will be financed through a mortgage loan. The rule is that, you have the obligation of paying up the mortgage loan based on the agreed terms. However, if you default, you stand the risk of losing the property to foreclosure. Because you will not want to lose the property, you will not want to default in payment.
To be sincere, a lot of people find it difficult to save enough amounts that private lenders will require as down payment before they can be granted mortgage loans. Besides the down-payment, there are other closing costs you will need to pay and this includes mortgage insurance. But you can avoid mortgage insurance if you are able to make down payment of at least 20% of the cost of the home. Twenty per cent down-payment is not a small amount. If the value of the property you are buying is $100,000, with 20% down payment, it means that you will need to pay as much as $20,000 as down payment. Remember that you can’t spend all your savings to make down payment. You still need to pay for other closing costs such as origination fee, appraisal fee, survey fee, recording fee etc. You will also be expected to have considerable amount that will help you make your monthly repayment for the initial few months. For people that can’t afford to pay large amount as up front payment, there are two approaches to follow: (i) You can shop for mortgage loans that don’t require large up front payment; or (ii) You limit your loan amount to the amount you will be able to pay the required up front amount conveniently. Let’s see how these play out.
Instead of 20% down payment on a loan of $100,000, if you are able to find a lender that will only require 10% up front payment, this means you will only need to pay just $10,000 instead of $20,000. However, this may necessitate that you pay mortgage insurance. On the other hand, seeking for property of lower value can help you limit your down payment. For example, if you opt for property that worth around $80,000, the 20% down payment will just be $16,000. At least, this is more affordable.
If you are looking for low down payment mortgages, you may need to shift focus from private lending institutions. Except you have a very high credit score with large income that can convince lenders that you won’t have problem repaying your mortgage, private lenders will require sizable down-payment. Also, the interest rates on their mortgage loans are quite high.
No Down Payment Mortgages
Do you have to put down payment on a home? Surprisingly, the answer is “No”. No down payment mortgages are available. The only constraint is that they are not available to all sundries. Below are examples:
VA Loans: VA Loans government backed loans which are made available through approved lenders to Veterans, Service members, National Guard, Reserve Member and their Surviving Spouses. No down payment is required on VA loans. Besides there are other features that make VA mortgage loans attractive. These features include low interest rates, low closing costs, no prepayment penalty and no private mortgage insurance. Another attraction about VA loans is that the loans are reusable. The credit score and debt to income ratio requirements are not stringent. Types of VA Loans available are VA Purchase Loans, VA Refinance Loans and Interest Rate Reduction Refinance Loan (IRRRL). VA Loans can be used to purchase home or for home improvement.
Read Also: VA Loans: Eligibility Requirements and Essential Features
Low Down Payment Mortgages
For people that don’t qualify for VA Loans, possibly you will be eligible for low down payment mortgages. A good example of this is FHA Loans.
FHA Loans: Just like VA Loans, FHA loans are insured by the government through Federal housing Administration. However, the loans require down-payment as low as 3.5% if you have FICO score of at least 580. If FICO score is less than 580 but within the range of 500 and 579, you will be required to make 10% down payment. Homeowners can access FHA Loans through the approved lenders. Unlike VA Loans, borrowers will need to pay Mortgage Insurance premium. The loans are available for first time homeowners and other people who meet the eligibility requirements.
Read Also: FHA Loan Requirements and How to Apply
Pros and Cons of Low or No Down Payment Loans
Pros
- Affordability: The main advantage here is that the borrower does not need to pay large amount at once before he can make his purchase. That is why FHA Loans are very attractive to first time homeowners especially people who have just graduated with limited savings. FHA Loans help individuals achieve their financial goals within limited period of time.
- Investment Opportunity: Money kept in a savings account cannot be regarded as an investment. There is tendency for you to deep your hand into your savings in order to meet your pressing needs. But if the money is tied down in a property, you cannot easily squander the money. In fact, you will be forced to be more disciplined in your spending so as not to default in your monthly mortgage payments.
- Time Value: You have a better value for your money. A dollar today is worth more than a dollar in a one year time. The money you keep in savings account can easily lose its value due to inflation. A dollar next year may not be able to buy what a dollar today can buy. In another word, a property you buy for $100,000 today may worth as much as $120,000 next year. This means you will even need greater amount to meet with the twenty per cent down payment.
Cons
- Longer Loan Duration: Because of the larger mortgage amount involved, you may need to stretch the repayment over a long time. A person that takes 20% down payment mortgage on $100,000 will only need to borrow $80,000. By this, he may be able to pay off the mortgage loan faster than somebody with no down payment mortgage of the same amount.
- High Debt to Income Ratio: Higher debt will definitely impact your debt to income ratio. This may have negative impact on credit rating. Besides, you may find it difficult to get new credits. If you manage to get new credits, it may be at a very high interest rates as lenders may consider you as high risk individual. When the debt to income ratio of an individual is high, the risk that he will default in paying back his loans becomes high too.
- Higher Interest: At times, low interest rates can just be a bait in disguise. When you stretch a loan over a long period, you will end up paying more interest.
- Large monthly payment: The larger your mortgage loan amount, the larger the amount you will need to pay on a monthly basis. This can create pressure on your finance.