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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