Don’t do it

Fannie Mae and Freddi Mac have started backing low down payment mortgages. You can get a home by putting only 3% down. Don’t do it! Remember the housing crisis that hit just a few years back? It occurred, in part, because of this type of low down payments. The low down payment sounds attractive, but if you don’t have the 20% to put down, don’t do it.

In order to qualify, the borrowers have to meet strict criteria.

  • Borrowers have to buy private mortgage insurance;
  • They need a credit score of at least 620;
  • They have to offer complete documentation of their income, assets and job status;
  • The borrowers are required to receive home ownership counseling.

Both of these programs are for fixed-rate loans given to first time homebuyers and those seeking to refinance. Fannie started backing the loans on December 13, 2014. Freddie will start offering them March 23, 2015.

These loans are geared to expand access to credit for first-time homebuyers. Typically, younger buyers have not saved a big lump sum because they are young and haven’t had enough time to save.

Already, Fannie and Freddie are backing mortgages with as low as 5% down. The Federal Housing Administration insures 3.5% loans.

Mark Palim, who directs economic and strategic research at Fannie Mae, feels it’s a welcome expansion of credit. He said, “It’s not a radical departure from what we’re doing now, but anything at the margins helps.” Palim also feels that the 3% loans will offer some advantages over the 3.5% down loans offered FHA. FHA requires borrowers to pay for private mortgage insurance premiums for the entire term of the mortgage — typically 30 years. This translates to an extra 1.35 percentage points to monthly mortgage rates.  For example, a loan carrying a 4% rate becomes a 5.35% mortgage. This translates to about an extra $80 a month for every $100,000 borrowed or $960 a year. This adds up to nearly $30,000 over the life of the loan.

In the Fannie and Freddie’s programs, borrowers are permitted to cancel their private mortgage insurance premiums once they have 20% equity in their homes, e.g. the mortgage balance drops below 80% of the home’s value or  they’ve made enough payments or the home’s value has risen. For example, if home prices increase 5% a year for three or four years, these borrowers may be able to cancel their insurance. Thus, saving tens of thousands of dollars over the next 26 or 27 years.

The programs sound attractive and might be appealing to many, but I caution to avoid them. Instead, save, save, save for the full 20% down payment. It might take you a few more years, but “remember only fools rush in where angels fear to tread” Alexander Pope.

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