“The biggest obstacle is the down payment,” says Malcolm Hollensteiner, head of mortgage production at Sandy Spring Bank, headquartered in Olney, Md. When buyers believe they’ll need to put down 20 percent they might feel shut out of opportunities. “If you’re nowhere close you may think you’ll never be able to do it,” he says. Yet mortgage lenders “can unlock the treasure chest of all these programs designed to make home loans affordable.”
From July 2019 to June 2020, 31 percent of the people in the market for a primary home were first-time buyers, according to the 2021 National Association of Realtors (NAR) Home Buyers and Sellers Generational Trends Report. The same percentage of first-time buyers were in the market during that period the year before.
Here’s what you need to know before going shopping for a loan:
Buying your first home can be exciting but requires planning and a precise understanding of your entire financial situation: What is your monthly debt-to-income ratio — that is what are your monthly expenses compared to monthly income? What does your credit report look like? Credit scores are based on data in your credit reports from the three credit reporting agencies: Experian, Equifax and TransUnion. Lenders will want to know all of this to determine how much you can afford to borrow and the likelihood that you will pay back the loan.
The median down payment for all buyers in 2020 was 12 percent, according to the NAR 2021 report. Among buyers ages 20 to 30 the median down payment was 6 percent. Yet it’s possible to put down less.
Before you even start looking online for homes, figure out what you can afford. “The important thing is talking to lenders,” Hollensteiner says. “Familiarize yourself with all the programs. There’s a lot of ways for prospective first-time home buyers to finance a property.”
Lenders can give you a preapproval letter before you begin shopping in person. “As soon as they want to buy a house that should be the first step, some type of preapproval,” he says.
Amy Goldstein, vice president, BMIC Mortgage in Rockville, Md., advises future borrowers on the rule of twos:
· Two years of W-2s or 1099s or two years of tax returns;
· The last two months of bank statements verifying your assets;
· Two pay stubs, equaling 30 days of income.
A preapproval letter, she says, is “like the golden ticket to go and look.” Know exactly what you can afford. “You need to know what you can buy. What is the biggest amount that you can afford? Look at that amount and below. Buy a home that you can afford and not default on,” she says.
Here’s a look at several programs that can help you get a low down payment mortgage:
These loans are available from bank, non-bank and credit union lenders. Check with a lender to see if it participates in government-insured loans.
Loans through the Federal Housing Administration (FHA), which is a part of the Department of Housing and Urban Development (HUD), require a minimum down payment of 3.5 percent, while the average FHA loan down payment is 4.4 percent. These loans are for the borrower who is ready for homeownership but may not have a lot of cash available.
FHA loans are for people who have been shut out of conventional housing loan requirements. They either lack a credit history or have a low credit score, according to the FHA. Other government-insured loans include Department of Veterans Affairs and Agriculture Department home loans. For VA loans, up to 100 percent financing is available.
A credit score of 580 or higher is required for an FHA loan with a minimum down payment of 3.5 percent, according to HUD. With a credit score between 500 and 579, the borrower would be limited to a maximum loan-to-value ratio of 90 percent, and a 10 percent down payment would be required. Loan-to-value ratio compares the amount of your mortgage with the appraised value of the home.
FHA loans require an upfront mortgage insurance premium of 1.75 percent of the loan balance as well as a 0.45 percent to 1.05 percent of loan amount each year, based on amount borrowed, loan-to-value ratio and loan term.
Mortgage insurance is required on loans for which the down payment is less than 20 percent of the home’s appraised value. “It adds a cost on top of the regular mortgage payment,” says Joel Kan, associate vice president of economic and industry forecasting at the Mortgage Bankers Association.
The buyer “has to work harder to get equity” in their home, he adds. An option, he says, is to wait longer to buy and save more for the down payment. In addition, he points out there are maintenance costs that come with homeownership. “It’s the biggest financial decision that most people will make.”
Government-sponsored enterprise loans
If you have good credit — 680 or higher — government-sponsored enterprise loans offered by Fannie Mae (Federal National Mortgage Association) and Freddie Mac (Federal Home Loan Mortgage Corp.) are an option. “These are conventional loans for people with good credit, are W-2 employed and don’t have a lot of debt,” says Goldstein. “The difference between FHA and these loans is the credit score threshold.”
Fannie Mae HomeReady and Freddie Mac Home Possible loans’ eligibility requirements are based on your income and where you live.
For more information on income guidelines for Fannie Mae’s Home Ready program, click here.
For more information on the Freddie Mac Home Possible income guidelines, click here.
Down payment assistance
Some buyers still may feel that a 3 percent down payment is out of their reach, and may need assistance raising it. For instance, buying a $300,000 home through the Fannie Mae HomeReady and the Freddie Mac Home Possible programs would require a $9,000 down payment. (The Fannie Mae97 standard product does not allow for down payment assistance.)
Some banks such as Bank of America and Sandy Spring Bank offer down payment assistance. For example, Sandy Spring Bank has the Closing the Gap Down Payment Assistance Program, which can be used with Fannie Mae Home Ready and Freddie Mac Home Possible mortgages.
In the example above, borrowers may qualify to borrow the $9,000 down payment enabling them to obtain 100 percent financing for their home purchase. “The important thing is talking to lenders,” Hollensteiner says. “Familiarize yourself with all the programs. There’s a lot of ways for prospective first-time home buyers to finance a property.”
In addition, you might be able to get the seller to pay some or all of the closing costs or obtain lender credits to cover some or all of the closing costs, he says.
State down payment assistance programs
In addition to bank and non-bank down payment assistance, there are state down payment assistance programs to consider. Some are grants that don’t have to be paid back ever or as long as you own or occupy your home for a required period of time. The most common are second mortgage loans from state and local governments, and have low or zero interest rates. The payments can be deferred or the loan is even forgiven over time.
DC Open Doors offers qualified buyers home purchase loans as well as down payment and closing cost assistance. For the MMP, home buyers need to be at or below certain household income limits, which vary by location and household size. Virginia Housing assists with homeownership, for example, through its Virginia Housing Loan Combo, which includes a down payment grant, a federal tax credit and a free home buyer class.
Homeownership counseling can educate first-time buyers of the requirements of purchasing a home.
“A lot of programs have a pre-closing educational requirement,” says Hollensteiner.
“Before you go to settlement, before you sign all the papers, you have to provide proof that you have met the requirements, that you understand the responsibilities” and potential difficulties of homeownership, he says.
The goal is to “reduce the rate of foreclosure in the future and to educate about what they’re about to go into,” says Kathleen M. Koch, executive director of Arundel Community Development Services, a nonprofit in Annapolis, Md., that works to create affordable housing opportunities and improve the lives of low-income individuals through community development.
To find a HUD-approved housing counseling agency in your area, call 1-800-569-4287 or visit a list of agencies at the HUD website.