The Center For Debt Management
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What Makes Low
Down Payment Loans Possible?

Simply put, mortgage insurance protects the mortgage lender against financial loss if a homeowner stops making mortgage payments. Lenders usually require insurance on low down payment loans for protection in the event that the homeowner fails to make his or her payments. When a homeowner fails to make the mortgage payments, a default occurs and the home goes into foreclosure. Both the homeowner and the mortgage insurer lose in a foreclosure. The homeowner loses the house and all of the money put into it. The mortgage insurer will then have to pay the lender's claim on the defaulted loan.

For this reason, it is crucial that the family buying the home can really afford it — not only at the time it is purchased, - but throughout the time period of the loan.

Although the cost of the mortgage insurance is paid by the home buyer, or borrower, the mortgage insurer works directly with the lender. Mortgage insurance is available to commercial banks, mortgage bankers, and savings & loans, and all of which offer mortgage loans to home buyers.

Remember that mortgage insurance is not the same as credit life insurance, also called mortgage life insurance. This type of policy repays an outstanding mortgage balance if the person who took out the insurance policy dies.

The Secondary Market

The lender's decision to use mortgage insurance is driven by the requirements of investors in the mortgage market. Because of the losses that could occur, major investors require mortgage insurance on all loans made with low down payments.

The three primary investors in home loans are Federal National Mortgage Association (Fannie Mae), Federal Home Loan Mortgage Corporation (Freddie Mac) and Government National Mortgage Association (GNMA). By purchasing and selling residential mortgages, Fannie Mae and Freddie Mac help keep money available for homes across the country.

Unlike Fannie Mae and Freddie Mac, Ginnie Mae does not actually buy the mortgages. It adds the guarantee of the full faith and credit of the U.S. Government to mortgage securities issued by private lenders.

The Two Choices: Government Insurance and Private Insurance

Now that we have explained how mortgage insurance works and why it is necessary, let's look at the basic kinds of mortgage insurance. Low down payment mortgages can be insured in two ways — through the government or through the private sector.

Mortgages backed by the government are insured by the Federal Housing Administration (FHA) or guaranteed by the Department of Veterans Affairs (VA) or the Farmers Home Administration (FmHA).

The minimum down payment required by FHA is less than 3%. For single-family homes, the standard limit for an FHA-insured mortgage ranges from $86,317 to $170,362 (in certain high-cost areas).

Although anyone can apply for FHA insurance, the other two government mortgage guarantee programs are much more targeted. The VA program is limited to qualified, eligible veterans and reservists. The FmHA insures loans for the construction and purchase of homes in rural communities. This program is very specialized, so contact your lender for the details.

Obtaining conventional financing is the alternative to obtaining a home loan backed by the government. Conventional mortgages are all home loans not guaranteed by the government, including those guaranteed by private mortgage insurers.

Although government and private insurance are based on the concept of allowing families to get into homes with less cash down, there are many differences between the two. Often, the lender or loan originator will play an important role in suggesting and deciding which insurance is selected.

Home buyers must make a down payment of at least 5 percent of a home's value to be considered for private mortgage insurance. The down payment requirement drops to 3 percent for special affordable housing programs geared toward first-time, lower-income buyers.

Private mortgage insurance is available on a wide variety of home loans and there is no pre-set limit on the loan amount. Although differences such as these may affect whether the lender prefers to work with government or conventional mortgages, your lender will discuss which one would be better for your situation.

With the wide variety of loans available, home buyers have the freedom to choose the type of loan that best suits their needs. Early on in the home buying process, it is a good idea to meet with several lenders to compare the types of mortgages they offer and shop for the best price and terms. Best of all, working with a mortgage insurer can be very easy — whether your loan is insured by the FHA or a private mortgage insurer — because your lender handles all of the arrangements.

By making lending money to home buyers safer, mortgage insurance helps more families get into homes of their own.

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