Two
years ago, John McPeak bought his first home. He and his fiancé were also
planning a wedding and planned to spend a good amount of their savings on
the
reception. Coming up with the
traditional 20% down payment for their $580,000 dream home wasn't
possible. There were too many expenses right then.
McPeak's mortgage broker came up
with a solution for the financial problem. He could take out two
mortgages, called a piggybacked loan, and be able to finance the home with
only 10% out of his pocket. The arrangement guaranteed that they did not
have to pay private mortgage insurance, which can be quite costly. There
was a savings of $100 from the monthly mortgage costs.
Finding enough money for a down
payment, especially in markets where home prices have soared, is the
biggest challenge for most first-time buyers. Lenders recognize this and
are creating a growing number of financing options. You can even find
mortgages out there for as little as 3% down. In other words, you could
place as little as $5,523 down on an $184,000 home, the average cost of a
home in 2004.
That might sound great. For those
without a lot of savings, these deals may make financial sense. But they
do have their cost. To begin with, you will have a higher interest rate if
you don't put much down. The lender is guessing that you are a risky
borrower because you don't have any equity in your home. You will also
have to purchase private mortgage insurance, which covers the lender in
case you default on the mortgage. The cost is usually an additional 0.5%
to 0.75% on top of your interest rate. On a $178,577 loan, 97% of the
medium home price, you could pay anywhere from $56 to $84 a
month.
But the costs may not override the
benefits to owning your own home. Beside the emotional benefits, owning a
home allows you to build equity and is the single biggest tax break
available to the average consumer.
Start by paying off your
debt
Many people make the mistake of
focusing on saving money and paying for things with credit cards and other
forms of credit. The best approach is to use your cash to eliminate your
credit-card and other high-interest debt, even if you have to put less
down on your home.
Credit card debt is the most expensive form of debt
you are facing. It limits your ability to save money. The average interest
rate on a credit card is around 13%, much
higher than a 6% 30-year fixed rate mortgage. Credit card debt also
affects how much you can borrow. The lender will not allow your monthly
debt payments to exceed 40% of your gross income. This means that you are
able to afford less home.
What can you afford?
This depends on how much you
can borrow and how much of a down payment you can make. Most lenders want
your housing expenses, including mortgage payment, taxes and insurance, to
remain under 28% of your gross income. Determine how much cash you have
for a down payment, keeping in mind that you will have to pay for closing
costs. The closing costs can add up to 5% of your new home's total value.
You should also save a little extra for emergency repairs once you move
into the home.
Different types of loans
Now that you know how much you can
afford, you are ready to start shopping around for the right loan. If you
have a steady job and great credit, you may be able to put down as little
as 3%. Rates vary widely and a low-down payment mortgage will have an
interest rate at least half a point higher than a conventional loan. With
our 97% mortgage example of $178,577, that extra half-point of interest
adds an additional $56 a month to the payment.
The more money you can find for a
down payment, the more options you have. If you put 5% down, you may
qualify with a smaller salary than those who put 3% down. By placing more
down, you are showing that you will not default on your investment.
Private lenders have come up with a
lot of programs designated for first-time home buyers. Washington Mutual,
for example, offers a mortgage with a 10% down payment with the remaining
10% of the down payment built into the interest rate, making it tax
deductible. This also eliminates the need for private mortgage
insurance.
Piggybacking your loan is increasingly common. This
type of mortgage is often referred to as an 80-10-10. You simply
place 10% of the home's value down. Then you take out your primary
mortgage, usually as a 30-year fixed rate, for 80% of the home's value.
Then you take out the remaining 10% as a 15-year fixed rate second
mortgage, at a less favorable rate. When you combine the two loan payments
you reach your total mortgage payment. The process is a little more
complicated and expensive than a traditional mortgage and has higher
closing costs. But it may be cheaper than paying for private
mortgage insurance.
Do you have questionable
credit?
If you don't have perfect credit,
you can still find a mortgage. Consumers with slightly blemished credit
are able to qualify for mortgages with fairly competitive rates. Fannie
Mae, for example, offers an expanded approval program for those who may
not qualify for fair-market value rates through traditional lenders.
If you credit isn't good enough for
a Fannie Mae loan, you may still qualify for a loan through the Federal
Housing Authority (FHA). The loans are government backed and have lower
credit criteria. You can put as little as 3% down and finance your closing
costs in your mortgage. The interest rates usually run around a quarter of
a point higher than those in a conventional loan.
There are no income limits for FHA
loans. However, these loans are primarily for first-time home buyers and
low to moderate income families. There are limits to how much you can
borrow. High cost areas are capped at $312,895.
Down Payment Assistance
If you still can't find a way to
come up with a down payment, HUD allocates money to each state for
distribution to low and moderate income families for housing assistance.
Most of the funding is used towards down payment assistance programs. Many
young home buyers may qualify for a grant or a loan of 3-5% of the sale
price for down payment and closing costs.
To qualify, you usually can earn no
more than 80% of the regions median income.
Don't confuse any of these programs
with no-equity loans being offered to people who already own their homes.
No-equity loans are high cost, high risk home equity loans that aren't
advisable.
