Zero-Down Payment Mortgages: Worth the Cost?

Coming up with a substantial down payment can be the hardest part of buying a home. Scoring a mortgage that requires no down payment sounds like hitting the jackpot.

You get funding for a home without having to put up any of your savings – what downside could there possibly be?

There are definitely some potential concerns to consider. And with the exception of two government programs, the availability of no-down payment mortgages varies.

The pros are obvious. You don’t have to put down a large sum of cash. You may be able to buy a home sooner than you thought possible, and your savings aren’t depleted.

The cons are a bit more nuanced, but they certainly deserve consideration.

Borrowing the full value of your property puts you at risk in the event that your home value declines. With very little equity from the start, you could end up "underwater" and stuck in your home in event that you want or need to move. Lenders perceive loans with a high loan-to-value ratio as high-risk, so your mortgage interest rate will likely be higher than it would be if you were putting down a significant down payment. Fees and the likelihood that your lender will require mortgage premium insurance will likely result in a high monthly payment.

Some zero-down mortgage programs may be going away

Over the past year or so, 1% and zero-down mortgages have been common among lenders. This is thanks to Fannie Mae and Freddie Mac, the quasi-government entities which back many mortgage loans, who have been allowing 3%-down loans. Many lenders will chip in the 3% difference in order to offer their customers a loan that requires no down payment.

This arrangement is on its way out for Freddie Mac loans, though. Effective November 1, 2017. Lenders can contribute toward down payments and closing costs, but the borrower must pay 3% down on their own. Where that 3% is obtained from is up to the borrower, but the borrower must be the one writing the check.

Some lenders intend to continue their low or no-down payment programs regardless of this change, there are other factors that could affect these programs, which we’ll get to in a bit.

Some zero-down programs are here to stay

Two government-backed true zero-down programs are not going anywhere: VA and USDA loans.

The U.S. Department of Veterans Affairs (VA) offers mortgages with no down payment for qualified veterans and active service members. Their interest rates are also usually lower than conventional loans, too.

The U.S. Department of Agriculture (USDA) issues zero-down mortgages which targeted mainly at rural borrowers, but some suburban areas do qualify.

A no-down payment mortgage could cost you in the long run

Freddie Mac and Fannie Mae are under the authority of an organization called the Federal Housing Finance Agency (FHFA). Recently the Agency has started keeping an eye on lender-funded payment discounts, especially when the lender charges a higher interest rate or additional fees in order to offset the cost of the down payment benefit. Their concern is that if the borrower is being charged higher fees or a higher rate in exchange for not having a pay a down payment, they may not be benefiting at all from having their down payment covered by the lender. This practice is called “premium pricing”, and the reason Freddie Mac is ending their lender-subsidized down payment programs could be to avoid running afoul of the FHFA.

Fannie Mae also offers a 3%-down program that allows lenders to pay the down payment instead of the borrower, and they have not announced any plans to alter or eliminate it. Fannie Mae does prohibit premium pricing, though, and they also prohibit lenders from requiring that lender-assisted down payments be repaid. They must be true grants with no strings attached.

It’s a good idea to shop around and look at options from multiple lenders when considering a low or no-down payment mortgage. There are many things to watch out for, such as premium pricing and high rates, so be sure you’re informed about the risks and certain that you’re actually benefiting from the mortgage loan option you choose.

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