Today’s conventional loans allow 3% down payments. You’ll need a higher credit score than with FHA loans but get a break on mortgage insurance.
Updated Aug 8, 2018 · 5 min read Written by Hal M. Bundrick, CFP® Senior Writer Hal M. Bundrick, CFP®
Senior Writer | Personal finance, financial planning, investing
Hal M. Bundrick is a former NerdWallet personal finance writer. He is a certified financial planner and former financial consultant and senior investment specialist for Wall Street firms. Hal advised families, business owners, nonprofits and trusts, and managed group employee retirement plans.
Reviewed by Michelle Blackford Michelle Blackford
Michelle Blackford spent 30 years working in the mortgage and banking industries, starting her career as a part-time bank teller and working her way up to becoming a mortgage loan processor and underwriter. She has worked with conventional and government-backed mortgages. Michelle currently works in quality assurance for Innovation Refunds, a company that provides tax assistance to small businesses.
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For years, the Federal Housing Administration was the king of the low-down-payment mortgage mountain. Now, Fannie Mae and Freddie Mac, the government-sponsored enterprises that provide capital to the mortgage market, are designing loan products for hopeful home buyers with skinny savings accounts.
With Fannie Mae’s HomeReady and Freddie Mac’s Home Possible, a 3% down payment — or what lenders refer to as 97% loan-to-value , or LTV — is available on so-called conventional loans . Conventional loans are the loan products most often issued by lenders.
Jonathan Lawless, vice president for product development and affordable housing at Fannie Mae, says today's low-down-payment FHA loans can be "expensive," with upfront and ongoing mortgage insurance premiums that last for the life of the loan. So Fannie Mae decided to build a competitive low-down-payment loan product of its own.
There are income limits wrapped into the HomeReady program, except in designated low-income neighborhoods. Fannie’s standard 97 LTV loan doesn’t have such restrictions, if at least one borrower is a first-time home buyer.
Though the FHA is known for its relaxed lending requirements — including a credit score minimum of 580 — Fannie’s HomeReady has a little wiggle room of its own. It allows parents to be co-borrowers — without residing in the home — and payments from a rental property can be considered as an income source. Borrowers can also have up to a 50% debt-to-income ratio and a FICO score as low as 620.
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But just clearing the DTI and credit score hurdles will not gain you approval. Lawless says Fannie Mae looks to eliminate "risk layering" — multiple factors that work against the borrower's creditworthiness. A low credit score would be one. Add a high DTI and you have two strikes against you.
It needs to be one or the other.
"It would never be possible to do a [97 LTV loan] with a 620 FICO and a 50 [DTI]," Lawless tells NerdWallet. "You're going to need compensating factors."
That could mean more cash in the bank, a higher income — or ultimately more than a 3% down payment.
Freddie Mac has its own 97 LTV program, Home Possible. The program assists low- to moderate-income borrowers with loans made for certain low-income areas. Repeat buyers may also qualify.
While Home Possible will continue to be Freddie Mac's "flagship" affordable mortgage product, Patricia Harmon, senior product manager at Freddie Mac, says there’s even more flexibility in a new program called HomeOne.
At least one borrower must be a first-time home buyer, but there are no income limits or geographic restrictions. And Harmon echoes Lawless’ caution regarding underwriting guidelines.
"If a borrower has a 640 credit score, that's not an automatic approval, nor is it an automatic decline. It would depend on a lot of other characteristics that borrower has," Harmon says. "The higher the credit score, the lower the debt, the more cash reserves in place — the higher the probability of being approved."
"Even though 3% sounds small, as home prices are rising, it's becoming a bigger and bigger amount and harder and harder to save for," Lawless says.
Fannie Mae and Freddie Mac are attempting to chip away at that barrier as well, allowing crowdsourced down payments, considering Airbnb income and even lease-to-own programs.
CMG Financial, a lender based in San Ramon, California, has created Homefundme.com, where prospective home buyers can tap the collective pockets of their social network.
"They can basically ask their family, friends, associates, colleagues, Facebook friends to give them five bucks here and there" toward a down payment, Lawless says.
Meanwhile, Seattle-based Loftium allows prospective home buyers to rent out a room in their future home to help seed their down payment.
In exchange for a future share of the rent from your room on Airbnb, Loftium will forecast the income and give you a percentage of that upfront, which you can then apply to your down payment.
The borrower will need to kick in 1% of the total down payment; Fannie Mae allows the other 2% to come from Loftium, Lawless says.
There’s even a lease-to-own initiative that Fannie Mae is testing.
"You start as a renter, but you also have the opportunity to buy [the home] at a fixed price in the years in the future," Lawless says.
Not every lender participates in these pilot programs, even with the endorsement of Fannie or Freddie. By talking to a few lenders, you can get an idea if they allow these new down-payment-building test programs.
If the testing goes well, Lawless says, these options could officially become part of Fannie Mae's loan programs.
"We've largely seen Freddie change their programs to match the programs that we have in place," Lawless adds.
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Access to mortgage funding, even with low down payments, still doesn't solve the problem of a lack of available housing. Conventional financing is also looking to help address this issue.
Fixer-upper funding wrapped into a home purchase mortgage — also with 3% down payments — may be one answer. Lawless says Fannie's renovation loan program has been "clunky" in the past, but has been recently updated and modified to be easier to use.
And Fannie's MH Advantage program, to finance manufactured housing, also offers 97 LTV financing.
FHA-backed loans are still drawing the lion’s share of first-time home buyers, yet 2017 mortgage numbers were down 4% compared to 2016. Meanwhile, the number of conventional loans for first-timers was up 18% for the same period, according to the Genworth Mortgage Insurance First-Time Homebuyer Report.
Does Michael Fratantoni, chief economist for the Mortgage Bankers Association, believe these 3% down conventional loan programs are having a significant positive impact on the first-time home buyer market?
"Yes, particularly for lenders who remain wary regarding False Claims Act exposure, conventional 97 loans are gaining traction," Fratantoni tells NerdWallet. The False Claims Act triggered a flood of lawsuits by the U.S. Department of Justice against lenders accused of fraud in the underwriting of FHA loans as part of the housing crash a decade ago.
As a result, many lenders began to shy away from FHA loans and welcomed the low-down-payment conventional mortgage programs.
"However, these loans remain more expensive than FHA loans for borrowers with less-than-perfect credit," Fratantoni says. "All-in costs — mortgage payment and mortgage insurance — are less for FHA loans than conventional loans if a borrower’s credit score is roughly 700 or lower."
Discuss your low-down-payment loan options, FHA and conventional, with three or more lenders, compare fees and mortgage insurance costs, and find out what works best for your situation.
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