The single biggest expense of buying a residence can be summed up in two words: down payment.
It's the part of the home purchase price that you don't finance, but pay out-of-pocket. And these days, very few mortgages – whether conventional or government-backed – are available without one: even federally-insured FHA loans require a down payment of 3.5%. That may not sound like a lot, but on a $200,000 home, you would need to put up $7,000. And for the more standard 20% down payment, it would be $40,000. Not to mention, home prices on the move again around the U.S., as the real estate market finally seems to be recovering from the subprime mortgage meltdown of 2008, which ushered in the Great Recession.
Before the aforementioned crisis, when home values were rapidly rising and credit guidelines were looser, no down payment (aka zero-down or no-money-down) mortgages were a popular option for just about everyone. No more. However, some homebuyers may be able to qualify for a no down payment home loan through one of several programs. The caveat is that they must be able to provide documentation of adequate income to repay the loan and must have good credit – at the very least a score of 620. Private lenders might require even higher scores.
Military families and veterans may qualify for a VA (Veterans Affairs) loan, which offers 100% financing. The VA loan program has been in place since World War II and is an insurance program that guarantees loans up to a certain limit. In most areas that limit is $424,100, but the limit is higher in counties with expensive housing.
In order to apply for a VA loan, borrowers must obtain a Certificate of Eligibility (COE) from a VA eligibility center by proving their military service. After obtaining a COE, borrowers can work with any lender that offers VA loans.
VA loans not only do not require a down payment, but the mortgage insurance of 2.15 points (a point is equal to 1% of the loan amount) can be wrapped into the loan. Loan qualifications vary from lender to lender, but in general, VA loans require a debt-to-income ratio of about 41%. (To learn more about VA loans, check out The Unique Advantages Of VA Mortgages.)
USDA Rural Development Housing Loans
Some potential buyers who live in specifically designated regions of the country may qualify for a U.S. Department of Agriculture (USDA) Rural Development Housing loan. Although the loans are for "rural" areas, some eligible locations are actually near towns. Check the USDA eligibility page to find out if the area where you want to buy is a designated area.
Qualifying for a USDA home loan requires not only location eligibility but also conforming to income limitations. Borrowers can enter their zip code, income and number of household members on the USDA website to find out if they meet the guidelines.
USDA loans are geared to low- and moderate-income households that have the income to afford the home payments but may be unable to save enough for a down payment. The minimum credit scores vary from lender to lender but can be anywhere from 600 to 640 or above.
Navy Federal Loans
Navy Federal Credit Union, the nation's largest in assets and membership, offers 100% financing to qualified members who buy primary homes. Navy Federal eligibility is restricted to members of the military, some civilian employees of the military and U.S. Department of Defense, and family members.
The credit union's zero-down program is similar to the VA's. One difference is cost: Navy Federal's funding fee of 1.75% is less than the VA's funding fees.
When Are No Down Payment Mortgages a Good Idea?
Well, if you need to buy a house now, and don't have any prospects for coming up with cash for a down payment – then anytime is a good time for a no down payment loan. Or, of course, if an irresistible buying opportunity comes your way. Mortgage interest rates have been at historic lows for some time, and some financial experts feel that now is the time to lock them in before they inevitably start to climb again.
When Are No Down Payment Mortgages a Bad Idea?
Putting no money down has its drawbacks. If you finance 100% of a home purchase, you have no equity in the property – that is, you don't own any of it outright, as you would if you'd made a down payment. And you won't accrue any substantial equity for years, until you've paid back a significant amount of the mortgage.
Because you have no skin in the game, so to speak, a lender might consider you a higher-risk borrower, and so will make you secure private mortgage insurance (PMI) prior to signing off on the loan. The purpose of the insurance is to protect the mortgage company if you default. Private mortgage insurance typically costs between 0.5% to 1% of the entire loan amount on an annual basis and, unlike the mortgage payments themselves, may not be tax-deductible, depending on your yearly income (see Private Mortgage Insurance: Avoid It for These 6 Reasons).
Finally, zero down payment mortgages often carry higher interest rates than regular mortgages, since lenders usually reserve the best terms for borrowers who can put up cash. For example, as of this writing, Louisville, Ky.–based Republic Bank is offering a no down payment mortgage with no PMI and no points: a seven-year adjustable rate mortgage (ARM) with an initial interest rate of 4.729%. This rate is significantly higher than that of marketplace lender SoFi (short for Social Finance). It’s also nearly a full percentage point higher than Wells Fargo’s advertised rate on a 7/1 ARM, which is 3.875% (but requires a 25% down payment). Your monthly payment with this Republic Bank loan would be $533 for every $100,000 borrowed for the first seven years; after that the interest rate adjusts once a year based on the LIBOR rate plus a margin of 2.75% (that's why it's called a 7/1 ARM).
Or you might pay more in fees and points. With San Francisco Federal Credit Union’s PoppyLoan, homebuyers who work in San Francisco or San Mateo counties and who buy a home worth up to $2 million in the Bay Area can put down 0% with 5/5 ARM amortized over 30 years: The initial interest rate is fixed for five years, and after that the rate adjusts once every five years. You’ll pay an origination fee of 1% of the loan amount, or $1,000 for every $100,000 borrowed. If you were borrowing $700,000 (a reasonable sum in a city where the median home price is over $1.1 million), you could get an interest rate of 3.75% if your credit score is 740 or higher. Your closing costs would be close to $19,000, including the $7,000 loan-to-value origination fee. Your initial monthly payment would be $3,241.81. The rate is close to half a point higher than the national average rate for 5/1 ARMs (but that’s not a bad tradeoff to make in exchange for having your rate adjust only once every five years instead of annually).
Alternatives to No Down Payment Mortgages
If no zero down payment loan program seems to work for you, all may not be lost.
Local Loans: Nearly every state, county and municipality in the country offers some type of homebuyer incentive program. These programs sometimes offer down payment assistance, closing cost assistance or low interest rate home loans or a combination of those features. Many are restricted to buyers by income level, and some, but not all, are restricted to first-time homebuyers. Many areas have programs designed to assist buyers in certain professions, such as teachers, medical personnel or first responders.
While not all these programs can eliminate the need for a down payment, some will offer a grant or an interest-free loan that will cover the entire down payment or a portion of it. The best way to find out about programs in your area is to search by state at the website of the National Council of State Housing Agencies.
FHA Programs: You can try a similar strategy with a FHA loan. Technically, these loans require down payments of 3.5%. However, FHA guidelines allow that down payment to be funded from a gift – it doesn't have to come from your own assets. The gift can be from a relative, fiancé(e), nonprofit organization, or other eligible down payment gift source. While it is never easy to ask family for money, it does in effect give you a no down-payment mortgage (and you could always privately work out a reimbursement plan later).
Another FHA niche offering is the Good Neighbor Next Door loan. Teachers, police officers, and some other public employees can buy a home with just $100 down. It's not quite 100% financing, but very close to it.
Piggy-back Mortgages: This strategy involves taking out two loans – one for 80% of the home's purchase price, the other for as much of the remainder as possible. Pre the subprime mortgage crisis, doing a 80/20% split (in effect, financing the whole purchase) was common; in today's tougher climate, the max might be an 80-15-5 type plan: You'll finance 80% with a primary mortgage, finance 15% with a second mortgage or home-equity loan, and make a 5% down payment. Yes, you're still having to put up some cash, but a lot less than usual, plus you avoid PMI. The home-equity or second loan will most likely have a variable rate or a rate higher than your primary mortgage, so you'll need to keep an eye on this loan and try to pay it off first.
Some lenders might still offer more generous splits, especially credit unions: See Choose a Low Down Payment Program to Avoid PMI?
Wait and Save: We know this isn't what you want to hear, but postponing the home-ownership dream until you can make the standard down payment might be the best option. It may come sooner than you think – especially if you have some savings in the right places already. For example, up to $10,000 can be withdrawn from an IRA for first-time homebuyer expenses, including a down payment, without incurring the normal 10% early withdrawal penalty.
The Bottom Line
Gone are the days where practically anybody could secure an easy mortgage with little or no money down. But means of doing so still exist, mostly from public programs, and from a few private lenders, too. While it might be tempting to take out a zero down mortgage today, especially when interest rates are so low, it’s important to think about how getting such a loan will affect your finances and debt burden in the long run. Buying a home is never a purely financial decision – it’s emotional, too – but take some time to consider the consequences. Understand all the elements that will go into your payments, and make sure you can fully afford them; also, make sure you have savings in the bank that can cover unexpected costs associated with homeownership.
Remember that if you do not make any down payment, you will lack equity in the property; be sure you won't need to sell for at least three to five years, because it will take at least that long to obtain an ownership stake. Of course it could be faster if the home rises dramatically in value, but you don't want to count on that.