“We’re seeing an increasing number of people choose low down-payment loans and take advantage of down-payment assistance programs,” said Michael Fratantoni, chief economist for Mortgage Bankers Association. “Lenders are trying to streamline the process for using gift funds for down payments, too, although they’re still being very careful to document the source of the money.”
These days, many buyers can choose from an array of programs offering down payments as low as 1 percent.
The “Home Possible” program from the Federal Home Loan Mortgage Corp. (Freddie Mac) allows first-time buyers with an income at or below the median for their area to buy with a down payment of 3 percent. The down payment funds can be a gift from a relative or an employer, or come through a down-payment assistance program.
“The rapid rise in home prices over the past 10 years means that a down payment is an even bigger barrier than in the past,” said Daniel Gardner, vice president for affordable lending and access to credit for Freddie Mac.
“Borrowers can also save on loan fees, mortgage rates and mortgage insurance premiums with the Home Possible program, which helps them afford the payments,” Gardner said. He recommends DownPaymentResource.com as a comprehensive source for borrowers who want to search for homeowner assistance programs.
First-time buyers can also find a 3 percent down payment option from the Federal National Mortgage Association (Fannie Mae). The agency’s Home Ready program for low- to moderate-income borrowers has lower fees and lower mortgage insurance requirements, said Jonathan Lawless, vice president of product development and affordable housing for Fannie Mae.
Both Fannie Mae and Freddie Mac also have guidelines for loan programs with a 3 percent down payment that are available to all first-time buyers, regardless of their income.
Some lenders, such as Guild Mortgage and Guaranteed Rate, provide down-payment assistance grants that allow borrowers to buy a home with as little as 1 percent of the home price for their down payment.
These first-time buyer programs require borrowers to take approved homeowner education classes. In addition, buyers who make a down payment of less than 20 percent need to pay private mortgage insurance (PMI), which is automatically canceled once borrowers have 22 percent equity in their home.
“Private mortgage insurance allows people to become homeowners faster, because they don’t have to wait to save 20 percent for a down payment,” said Claudia Merkle, president of National Mortgage Insurance Corp. “Even if you have cash, you may want to make a lower down payment and use the cash to buy down your mortgage rate for a few years to make the payments more affordable or to keep in the bank for emergencies.”
Merkle estimates that monthly PMI cost on a $250,000 home for a borrower with a 760 credit score and a 5 percent down payment of $12,500 would be $71.25. That same borrower making a 10 percent down payment of $25,000 would pay $48.75 per month in PMI. That same borrower making a 20 percent down payment of $37,500 would pay no PMI.
Low and no down-payment loans are also available through guarantees from government agencies such as the Federal Housing Administration (FHA), Veterans Affairs (VA) and the Agriculture Department (USDA), which provides loans for properties in designated rural and suburban areas. FHA loans, which were about 10 percent of all new loans during the second quarter of 2018, require borrowers to pay mortgage insurance for the entire loan.
To evaluate all the available loan programs and to review your eligibility, it’s best to consult a lender who can compare rates and options based on your individual needs.
Ability to repay
In the aftermath of the housing crisis, no and low down-payment loans — as well as adjustable-rate mortgages (ARMs) — were among the culprits of the flood of foreclosures.
“Before the housing crisis, a natural response for some people was to apply for an adjustable-rate mortgage so their payments were lower,” Fratantoni said. “In 2005, 35 percent of mortgages were ARMs. But now, borrowers need to qualify for the loan at its highest possible rate, so they don’t have the advantage of being able to qualify for a lower payment. We’re not likely to see the ARM share of the market get to 35 percent again.”
“The big lesson everyone learned from the crisis was that it’s not smart to layer risk,” Fratantoni said. “It wasn’t just the low down payment; it was also the lack of documentation of loans. Now, when someone buys a home with a low down payment, we make sure there are compensating factors, such as stronger credit or a lower debt-to-income ratio.”
Mortgage application denial rates have steadily declined as the housing market and economy have improved in the post-recession years, according to CoreLogic, a data analytics company. In 2017, only about 10 percent of applications were turned down, compared with about 19 percent in 2007.
But Joe Tyrrell, executive vice president of corporate strategy for Ellie Mae, a mortgage software company, said that’s because would-be borrowers are self-selecting themselves out of the housing market.
“People still have the misunderstanding that they need a FICO score above 720 and more cash for a down payment, so they don’t apply for loans because they assume they’ll be denied,” Tyrrell said.
According to Ellie Mae’s most recent Origination Insight Report, 72 percent of all purchase loans were made to borrowers with a FICO score above 700, and 47 percent had a score above 750.
Since 2015, the No. 1 reason for mortgage denials has been a high debt-to-income ratio, according to CoreLogic.
Borrowers who choose a low down-payment conventional loan will also need to be approved by the mortgage insurance provider.
“It’s important not to set the bar for failure, and to approve borrowers who can show us they have the ability to repay the lender,” Merkle said. “The minimum FICO score we require to insure a loan with a 3 percent down payment is 620. Just a few years ago, we required a minimum score of 680 and wouldn’t insure loans with a down payment of less than 5 percent.”
Mortgage insurance companies base their approvals and pricing on the same factors as lenders: credit scores, debt-to-income ratios and the amount of down payment.
“Some lenders are starting to look at alternative information more than just credit scores,” Tyrrell said. “Experian and FICO and Finicity, a financial tech company, are starting a pilot program next year called UltraFico, which will bring in banking data instead of relying entirely on credit reporting data. Lenders will be able to look at deposit records and incidents of overdrafts, which could help people who have a solid checking account balance but don’t have a well-established credit history.”
Finding new ways of evaluating credit could help millennials, many of whom don’t have car loans and avoid credit cards, Tyrrell said.
Tracking nontraditional income
Although self-employed individuals have always been able to use their tax returns to prove income, a growing number of borrowers have income from several jobs, or supplemental income from a second job or from short-term rentals. Fannie Mae has a loan refinance program that allows short-term rental fees, such as fees from renting a room to Airbnb guests, for income qualification.
Lenders are looking for a consistent two years of income from a job, so even if someone thinks their Uber driving will bring in an extra $1,000 per month for the mortgage, it can’t be counted until a lender can average that income over two years, Tyrrell said.
“The pre-housing crisis approach to self-employed people and others without standard W2 income was to allow people to use ‘stated income’ without documentation,” Fratantoni said. “That turned out to be a bad idea when it was overused, and it’s prohibited by regulations. Now, we’re seeing an increasing use of technology to track cash flow to find a stable level of income and evaluate what a borrower can safely handle over time. There’s so much effort around how to deal with gig economy income that I think we’ll see more solutions in the next couple of years.”
At the same time, Lawless said, lenders realize it would be too risky to look at just a few months of income from a side job.
One solution to evaluating nontraditional borrowers who have fluctuating income from several jobs or who own rental properties that generate income is to review their bank statements, said Scott Reise, a regional manager for Guaranteed Rate in the Washington area.
“We can look at a borrower’s cash flow to establish income we can use to determine whether they can qualify for a loan,” Reise said. “I think we’ll see more lenders create niche products in 2019 to serve people who have good credit and always pay their current mortgage, but own a business or have fluctuating income. More people are starting businesses, so there will be more demand for this type of loan product in the future.”
To increase affordability, some people partner with family members, friends and equity-sharing companies to buy a home. Nationwide, 17.6 percent of all single-family home purchases during the second quarter of 2018 were made by co-buyers (multiple, non-married buyers listed on the sales deed), according to ATTOM Data Solutions, a property database in Irvine, Calif.
“There are companies out there that are helping people facilitate the process of buying a home together with legal arrangements and even matching potential families who want to buy together,” Lawless said.
Lenders are increasingly seeing loans with multiple borrowers, not just one or two people on the loan, which can make a difference in the debt-to-income ratio, Fratantoni said. The credit scores of all borrowers need to be evaluated to approve the loan.
Although complexities such as multiple borrowers and numerous sources of income can make the mortgage loan process harder, tech innovations are streamlining the process for lenders and consumers.
After buying homes four times, Adele Hook and her husband dreaded the thought of applying for a mortgage for the vacation home they wanted on Fenwick Island in Delaware. This time around, though, they found the experience much smoother.
“We did almost everything online, just scanned and uploaded documents into the portal and followed the checklist,” Hook said. “We talked over loan options on the phone with our lender, Dan Varda [branch manager and vice president of mortgage lending for Guaranteed Rate] and never even met him in person until the closing.”
Five years ago, Hook said, the entire process was a nightmare. This time, it was painless and fast, even though her husband is self-employed and they were buying a second home, which often requires extra scrutiny by lenders.
“We’re making investments in big data and advanced analytics to serve mortgage lenders, so they can provide better service to borrowers,” said David Lowman, executive vice president for single-family business for Freddie Mac.
Borrowers are already benefiting from an easier and faster loan application process, said Martin Logan, chief information officer for Guaranteed Rate, a mortgage lender, now that documents can be uploaded into a safe portal by consumers or transferred directly from third-party companies.
“The process is more secure than when people had to fax or email documents,” Logan said. “Documents are less likely to get lost, and the whole process is faster. Now, consumers can give us their Social Security number and a few passwords for their accounts, and we can automatically connect to their bank account and see updated information.”
Automated verification of income, assets and deposits allows the lender to see more data at the very beginning of the loan process, which speeds up loan decisions, Tyrrell said. Research on Ellie Mae’s digital loan service estimates that it saves lenders about $1,000 per loan, which can be passed onto borrowers.
In addition, lenders can use data analytics for automated appraisals under some circumstances, which saves consumers $500 in appraisal fees, as well as an average of 10 days during the loan process, Lowman said.
Eventually, Logan said, more lenders will use machine learning and artificial intelligence to predict risk.
“Regulations that are in place to keep people safe and to stop discriminatory lending make it hard to rely entirely on technology,” Logan said. “While it’s an advantage that technology is colorblind, you run the risk of not helping marginalized people if your machine is set to approve only the people with highest probability of repaying the loan.”
For now, Logan said, the loan process is faster because computers can instantly access data from financial institutions and the IRS.
“Getting a bank statement online saves an average of six days,” he said. “Loan costs are coming down because of that speed.”
Borrowers should expect to see more innovation in the mortgage industry over the coming years, but Lowman emphasizes that the main goal will always be to make sure consumers are borrowing responsibly and can sustain homeownership.