Column: East Bay Real Estate with Nancy Bennett – Can You Really Buy a Home in Claycord with Less Than 20% Down?

September 3, 2014 · 21 comments

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Can You Really Buy a Home in Claycord with Less Than 20% Down?….

Yes, you can – you can even put as little as 3.5% down with an FHA loan. And depending on your specific situation, it may make sense.

FHA loans have taken on renewed importance in today’s market. What’s an FHA loan? It’s a mortgage insured by the Federal Housing Administration, a government agency within the U.S. Department of Housing and Urban Development. Borrowers with FHA loans pay for mortgage insurance, which protects the lender from a loss. That insurance allows lenders to offer FHA loans at good interest rates, and with flexible qualification requirements.

All mortgage loans contain financial risk – you must be ready to assume major responsibility when you apply for a mortgage. But the days of high risk loans are gone for now, and luckily for all of us there are safer alternatives available – even some with low down payments.

In my experience, many people misunderstand FHA loans. Let’s take a look:

A young family wants to buy a home and they have been saving money for a few years. They don’t have 20% to put down on a $500,000 house, but they have a good chunk of change, great credit and are eager to stop paying rent.

They easily qualify for an FHA loan, can afford the mortgage payments, homeowners insurance, taxes and interest – AND the MIP (the FHA version of PMI (mortgage insurance) that is required on these loans.

Should they wait a few years until they can put 20% down?  Or should they buy a home at today’s prices, start enjoying a tax write-off and the benefits of homeownership right now? And perhaps sell, refinance or even rent out this home in the future?

Pros and Cons

  • Interest rates on FHA loans are lower than conventional loans. Right now, they are hovering around 3.75% for a 30-year fixed. Conventional loans are slightly above 4%.
  • You can qualify with a relatively low credit score. A score of 620 is fine, and some lenders will even go to 580 (this is compared to a score of 680-700 required to get a decent rate on a conventional loan).
  • You do not need to be a first time buyer – anyone can qualify.
  • These loans require that the home be your primary residence, and not an investment property. However, if you buy a building with 2-4 units, and you will be living in one of the units, then you can still qualify for a 3.5% down FHA loan, and the loan limits are higher. Check out the details from HUD.
  • For a single family residence in Contra Costa County, the maximum loan amount is $625,500. That means, you can buy a home costing $648,000 total, put 3.5% down and get the rest FHA financed. There are plenty of homes selling in this range in our area – check out homes in Clayton and Concord selling for $600K or less right now.
  • You must get FHA Mortgage Insurance (MIP – essentially the government version of PMI) for the life of the loan. Unfortunately, MIP is quite expensive – around 1.25%. Depending on your loan amount, that could be roughly $400-650 in mortgage insurance each month.
  • Every home purchase transaction includes some closing costs – so in reality you often need to have more than 3.5% saved up. For people with very little savings, this can be a barrier, depending on the mortgage broker you work with. As a very rough estimate, closing costs (appraisal, lender fees, title, property tax, homeowners insurance, prorated interest, etc.) might total around $8,000 on a $600K loan. Some lenders, such as the financing team I work with, have ways of crediting a portion of closing costs, allowing home buyers to really put about 3.5% down.
  • There is no requirement to have a few months’ worth of mortgage payments (reserves) in the bank to get an FHA loan, but friends, it is still a very good idea to have 6 months’ of payments available for an emergency.
  • FHA mortgage loans can be transferred from one person to the next – your future buyer can assume your FHA mortgage loan from you. If you secure a low interest rate, this can be a huge benefit and may help you sell your home in the future, when interest rates are higher.
  • FHA loans can work well for applicants with little credit history. You must provide proof of steady income and have been employed for the past two years. Debt to income ratios, including the new mortgage payments must total about 30% of your gross income.

FHA loans sound pretty good – so what’s the downside?

The property has to be appraised by an FHA-approved appraiser, and it must meet certain conditions. And of course there’s the mortgage insurance premium (MIP). You need to educate yourself on MIPs, but in a nutshell, if the loan’s starting balance is higher than 90% of the appraised value, the MIP will last the lifetime of the loan.

Moreover, since an FHA mortgage has a very low down-payment, you will end up paying more interest than if you had a conventional loan with 20% down. This is a very important factor to consider when looking for a mortgage. In my opinion, if you are financially capable of paying 20% down, now or in the near future, then you should opt for a conventional mortgage since it will save you a lot of money in the long run.

So when can an FHA loan be a good idea?

If you make a solid income today but don’t have much savings … and you take your credit seriously … if you are certain you want to be a homeowner and have a good sense of the home and neighborhood you want … then this option can make sense. It can make more financial sense to buy now than waiting 4-5 years to be able to save $100,000 or more for a 20% down payment and a conventional loan. By that time, you may be paying more for a home and more in interest.

Ask yourself, what is likely to happen with home values in the community I like over the next few years?

If it’s your sense that values are likely to rise, then one approach would be to buy the home you want now with an FHA loan, then consider refinancing in a few years with a conventional loan. I am a bigger fan of conventional loans … but this would be a reasonable path for the young family profiled above. If they wait a few years to save 20% and watch home prices move ever upwards, they may be priced out of the market for many years.

Until next time …. Nancy

Nancy Bennett, REALTOR, Keller Williams East Bay CalBRE 01399870

Nancy Bennett has over 20 years of sales and marketing experience, with 10 of those years selling real estate in the East Bay. She’s an award-winning real estate agent in Contra Costa County, the #1 Realtor in The Crossings neighborhood, and she heads up The Bennett Team – the leading real estate team at Keller Williams East Bay. She’s won the Five-Star Professional Award in Real Estate for 2012 and 2013.

Nancy is also a member of the National Association of Realtors, the California Association of Realtors, the Contra Costa Association of Realtors, the Fortune 400 Masterminds, and Contra Costa Realtors in Motion. She serves on the Agent Leadership Council, as well as being a faculty member and mentor to new agents at her office.

Nancy is a licensed foster parent and a volunteer with local organizations such as Meals on Wheels and Youth Homes in Walnut Creek.  For more information, please visit www.BennettBetter.com or reach Nancy directly at: Nancy@BennettBetter.com.

1 Sam September 3, 2014 at 4:01 PM

I would strongly recommend that anyone looking to buy a home have the 20% saved to put down. FHA Mortgage Insurance and PMI (Private Mortgage Insurance) is just yet another added expense on top closing costs, property taxes, homeowners insurance, maintenance, so forth. You want to own the home, not the home to own you.

2 trying September 3, 2014 at 4:02 PM

The real challenge with FHA is that sellers around here don’t accept them. We are in year two of our WC house hunt and have been told time and time again that FHA loans are looked down upon. Some realtors wouldn’t even accept our offers with the FHA loan. I think this negative perception should also be of note for would-be buyers.

3 Concord Mike September 3, 2014 at 4:15 PM

Nancy, great article, but I am a little unclear about this point:
” You must get FHA Mortgage Insurance (MIP – essentially the government version of PMI) for the life of the loan. Unfortunately, MIP is quite expensive – around 1.25%. Depending on your loan amount, that could be roughly $400-650 in mortgage insurance each month.”

How exactly does this work? 1.25% annually tacked on to the remaining balance of the loan? If you sell the house and someone else assumes the FHA loan, will they also be required to pay 1.25% even if they put more than 20% down for the purchase?

4 Cowellian September 3, 2014 at 4:48 PM

Are home loans even assumable anymore? Back when VA loans were 13%., a lot of sellers advertised assumable lower-interest mortgages as an inducement to buy. But it’s been a very long time since I’ve heard anyone discussing assumable mortgages.

5 tired of taxes September 3, 2014 at 4:59 PM

@2, why would a seller not accept an FHA loan? Money is money right? So the seller, upon closing, will have the same money whether the buyer took an FHA loan, an ARM, a traditional fixed rate or outright cash.

The only reason I can think of that FHA loans would be looked down upon is that the deal might have a higher chance of falling through because of the buyer’s less than stellar credit.

6 #3 September 3, 2014 at 5:33 PM

why would anyone want to assume a crappy loan?

7 Justin September 3, 2014 at 5:45 PM

Maybe the real key takeaway here is that if you don’t have the 20% or even anything close to it you shouldn’t be purchasing a half a million dollar home. Yes, the Bay Area is expensive but homes can be had for far less than that.

Invest in something cheaper now and sell up in a few years.

8 Beasty September 3, 2014 at 7:30 PM

Up until a couple years ago FHA loans only had PMI until you paid it down to 70% I believe. Then it dropped off. Usually took around 5 years or so for most people. Now they never drop off lol. You could refinance down the road to get rid of it once you build equity.

The buyer won’t assume your loan they will come in with their own loan from their bank

Military vets with VA loans can get 1% down I think

9 Anon September 3, 2014 at 7:36 PM

Some of the more affordable options (under 500k) in the Bay Area are usually multiple family units that have HOA which can be a whole other headache and added monthly expense. Sometimes buyers think well if I’m paying $300 a month in HOA dues for this place then why wouldn’t I just pay $300 more in a mortgage for a single family home? Another thing to think about is is something major happened and the HOA fund was too low to cover it and in turn there is a reassessment of dues.

10 Kad September 3, 2014 at 8:03 PM

A VA loan is the way to go if you served in the military. The trick is to find a realtor willing to go for it. Thankfully, our real estate person, who had never done one before, took a chance and it all worked out. The title company said there was less paperwork than a traditional mortgage.

11 Cowellian September 3, 2014 at 9:43 PM

I just got a 0% down VA loan. Since we bought our first house with a VA loan, I was very surprised to find out that we could reuse my VA benefit. This time, the VA rate was much lower than an FHA or conventional loan.

12 Tom September 3, 2014 at 11:07 PM

As long as you don’t bury yourself financially, go for it.

If you feel you can’t afford to own a home, you probably can’t. Renting is better than foreclosure any day of the week.

Everyone’s financial situation is different. Listen to the experts.

Personally, I’m old school when it comes to home loans. I’ve never bought any home without 20 percent down….or more.

13 Shiloh September 3, 2014 at 11:36 PM

@Concord Mike, it’s included in your mortgage payment every month and is paid via an escrow account just like property taxes.

14 Kad September 3, 2014 at 11:37 PM

We had the 20% down but why use your cash if you don’t have to. Since we could get a VA loan, we did. My husband had used it before. Just like Cowellian said, you can re-use it. It covers flood and earthquake. We refinanced and no longer have the VA loan and after the Napa quake I am thinking maybe we should have kept it.

15 P-Hillian September 3, 2014 at 11:40 PM

20% down is great, but locking in near historically low rates for perhaps 30 years is a bigger win from a personal financial planning perspective. So, if you must wait years to save up 20%, that might mean an unfortunate missed opportunity.

Also, we shouldn’t lump PMI and FHA together. If you have good credit and at least 5% down, your cost with PMI will be much lower than FHA, and with FHA, you must hold insurance for life, whereas PMI premiums cancel at 78% loan to value.

16 Shiloh September 3, 2014 at 11:41 PM

@tired of taxes, I think you hit the nail on the head. Also, the stricter inspection rules are probably a pain. I guess if the only people making offers on your house are FHA then, of course, you would sell to one of them. But if there are multiple offers, you go with the simplest one . . and those who can afford a conventional loan are those who can afford to outbid the FHA people, right? ;)

17 Cracky McGee September 4, 2014 at 6:29 AM

I agree with Sam #1! Don’t buy what you can’t afford for the long term.

18 Shiloh September 4, 2014 at 8:24 AM

Nancy, can you address some of the questions raised here about PMI and whether or not it drops off and when? I know things have changed a lot in the past few years

19 green September 4, 2014 at 9:54 AM

first time buyers cannot afford 20% down. that is too high. 0% down is better. they had 0 down mortgages in the early 90’s for first time buyers. i assume they still have them.

20 CoCoOld September 4, 2014 at 10:55 AM

@Kad,
My husband and I are both retired reinsuance people. My husband was the EQ expert for his company. The PML (probable maximum loss) for a one-story frame dwelling is 10%. The deductible for EQ insurance is…10%! The PML models used for these calculations are for earthquakes along the lines of the ’06 quake and larger. Like 8.8 and larger. An earthquake of this size is going to cause a lot more problems than homes sliding off foundations. Think mass destruction. Most EQ insurance companies will probably go bankrupt. It will be FEMA for most folks anyway. We say save your money on EQ insurance. Put it a savings account earmarked for emergency funds. That’s what we do anyhow.

21 Busy mama September 5, 2014 at 3:07 PM

I just looked up the info on FHA – MIP and unfortunately, there is no short answer – the devil is in the details! Here’s a good article: http://themortgagereports.com/7570/fha-mip-cancel Basically it’s going to depend on the exact details of your FHA loan. There are other good articles online.

I’ve become a faithful reader of this column and am pretty sure she’d say to call a trusted mortgage broker and get the lowdown for your personal situation.

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