Pros and Cons of Low Down-Payment Mortgages

Since the financial crisis, it has been difficult for many people to qualify for home loans. To help more people get mortgages, the federal government said that it plans to expand the availability of low down-payment mortgages.

Freddie Mac’s last low down-payment mortgage program was discontinued in 2011. Fannie Mae had one that it ended last year; they decided to end the program when the F.H.A. increased the fees that it charges for guarantees.

Possible Risks?

Many studies have shown that home buyers who put down at least 20 percent have a lower default rate than those who make smaller down payments. Additionally, people who put down very small down payments wind up at risk if housing prices fluctuate. If the value of their house goes down, they wind up upside down on their mortgages right away.

But, with current housing costs, a 20 percent down payment is outside of many borrowers’ means. Take Boston, where the median home value is $439,000. A buyer putting down 20 percent would have to come up with almost $88,000. It’d take someone who earns $50,000 a year and saves 10 percent of income 17 and a half years to save that much.

And, there are other groups’ analyses that suggest that lower down payments are not as risky as you might think. The Urban Institute did a comparison between borrowers who had down payments between 3 and 5 percent and borrowers whose down payment was between 5 and 10 percent of the loan. Those who put in the lower down payments had lower rates of default when their credit ratings were high. Fannie Mae will consider factors such as borrowers’ annual income and the amount that they have in the bank when approving low down-payment loans.

The borrowers will have to carry private mortgage insurance to qualify for low down-payment loans. Fannie Mae’s charter prevents the organization from granting mortgages for more than 80 percent of the cost of a house.

Raising Your Credit Score

If you are cash-poor but feel that you have the financial skills and commitment to make housing payments on time, increasing your credit score can make it easier for you to qualify for a low down-payment mortgage. Many people who have had issues such as medical bills or divorce can have credit scores that wind up lower through no fault of their own. And, many younger adults or people who have always chosen to use cash will find that their credit history is considered thin. In each of these circumstances, there is a lot that can be done to increase your credit score and make it more likely that you will qualify for a loan. A few steps that can help to quickly increase your credit score include:

• Check your credit reports for errors. Last year, the FTC performed a study that showed that 5 percent of consumers have errors on their credit report that can result in problems getting a loan. One in 10 consumers saw their credit scores change after correcting errors. Make sure you get all three reports, since they might contain different information from one another.
• Pay off debts in collections. Unpaid collections can significantly harm your credit score. Contact creditors to make arrangements to pay off debts. In some cases, you may be able to settle for less than the total of the debt. In others, you may be able to make arrangements to pay in installments.
• Consider consolidating loans. Having too many installment loans can drag your credit score down. Consolidating loans reduces the number of open loans you have, which can improve your credit score.
• Pay down your credit cards. Another factor that creditors look for is the relationship of your current debt to your available credit. If too many of your cards are near the limit and you have a balance on all of them, it can look to creditors like you are overextended. Many financial experts recommend that you never use more than 30% of your available credit. Some are even more conservative and recommend keeping 10% or less of your credit utilized at all times.

It remains to be seen how the new low down-payment loans will play out. With luck, these new loans will open up home ownership opportunities to a larger pool of borrowers who have good credit but less available cash. By working on erasing any issues that tarnish your credit score now, you can better ensure that you are in a good place to qualify for the loans when you have the chance.