3% Mortgages Are Back – Is This a Good Thing?

The 3% mortgage is back. After years of turmoil in the housing market and recriminations on whose to blame, the low down payment mortgage has surfaced again. The 3% mortgage will mean more flexibility for homebuyers, and in some cases, for those looking to refinance as well. Until now, borrowers had a choice between conventional loans, with a minimum 5% down payment requirement, or FHA loans, with a down payment requirement of 3.5%.

All that changed on December 8th, when Fannie Mae (“FNMA”) announced the roll out of their MyCommunityMortgage, and Federal Home Loan Mortgage Corporation, better known as Freddie Mac, announced their Home Possible Advantage program. Each will require a 3% down payment, resulting in a 97% mortgage.

The Purpose of the 3% Down Mortgage

Big picture, the purpose of the 3% down mortgage is to inject fresh credit into the housing market. Though the housing market has recovered in the past few years, that recovery is hardly an across-the-board phenomenon. Lowering down payment requirements for first-time homebuyers could be just what’s needed to improve the soft spots in the market, and increase housing liquidity.

According to research conducted by Fannie Mae, the main obstacle to homeownership for first-time home buyers is saving money for down payments and closing costs. Lowering the down payment requirement from 5% to 3% will help ease that problem.

According to Andrew Bon Salle, Fannie Mae Executive Vice President for Single Family Underwriting, Pricing and Capital Markets:

“Our goal is to help additional qualified borrowers gain access to mortgages. This option alone will not solve all the challenges around access to credit. Our new 97 percent LTV offering is simply one way we are working to remove barriers for creditworthy borrowers to get a mortgage. We are confident that these loans can be good business for lenders, safe and sound for Fannie Mae and an affordable, responsible option for qualified borrowers.”

Qualifications for the 3% Down Mortgage Program

Since the down payment requirement will be more liberal, the program has limits, as well as strict standards for borrowers:

  • Available for new home purchases and limited cash out refinances
  • At least one borrower must be a first time homebuyer for purchases
  • Existing mortgages must be held by FNMA or FHLMC on refinances
  • Regional median income limits apply on certain loan types
  • Fixed Rate loans only – 15 to 30 years
  • One unit principal residence – no indication if this includes Condos – and no manufactured homes
  • Minimum credit score – 620 (You can check your credit score here)
  • Income, employment and assets must be fully documented
  • At least one borrower must complete a home ownership counseling program
  • Mortgage insurance is required
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The 3% Conventional Mortgage VS. The 3.5% FHA Mortgage

FHA loans require a 3.5% down payment, so how is the 3% conventional mortgage a better deal?

Well for starters, the FHA 3.5% down payment requirement is higher than the 3% requirement for the conventional. The conventional 3% down requirement means you’ll need to put $6,000 down on a $200,000 purchase. The FHA 3.5% down payment means you’ll need $7,000 down on a $200,000 purchase – an extra $1,000.

But the comparison gets even more imbalanced when it comes to mortgage insurance.

For a 3% conventional mortgage, 18% mortgage insurance coverage (PMI) is required. Assuming your credit scores fall somewhere between 620 and 679, the mortgage insurance premium factor is .94%. If your mortgage will be $200,000, your annual premium will be $1,880, which works out to about $157 per month ($1,880 divided by 12 months) added to your mortgage payment.

For an FHA loan, the mortgage insurance costs are considerably higher. FHA loans require that you pay two levels of mortgage insurance – 1.75% upfront, plus 1.35% per year.

If you take an FHA mortgage for $200,000, you have to pay the upfront portion of $3,500 ($200,000 X 1.75%). This is usually added to the loan amount, so you won’t have to come up with it at closing. However, it will increase your monthly payment, since the new principal balance of your loan will be $3,500 higher.

Then there’s the annual premium. At 1.35%, that works out to be $2,700 ($200,000 X 1.35%). That’s $225 ($2,700 divided by 12 months) per month added to your mortgage payment. On the 3% conventional loan, it’s just $157 per month. You’ll be paying an extra $68 per month ($225 – $157) with an FHA loan – plus the effects of the upfront mortgage insurance (the $3,500) on your mortgage payment.

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The 3% conventional mortgage means less money at closing, and a lower monthly payment.

But that’s not all. On conventional loans, your mortgage insurance can be canceled when the value of the property reaches the point where the outstanding mortgage balance falls below 80% of the property value. With FHA loans, mortgage insurance is permanent.

Before You Dive In – Understand This Is a High Risk Loan

It’s worth noting that the 3% down conventional mortgage is not new at all. 97% loans were quite popular up until the mortgage meltdown in 2008. Various studies have concluded that no- and low-down payment mortgages made a significant contribution to the meltdown. If you are considering buying a home, and want to take advantage of the 3% mortgage, you should take the previous history to heart.

The reason why low down payment mortgages were a factor in the meltdown was because borrowers who have them had little or no equity in their homes. That lack of equity made it difficult to refinance, and was a significant factor in strategic defaults (people abandoning their homes because they were worth less than the outstanding mortgage balance on them).

If you take a 3% mortgage, you will be in the same situation, at least until the value of your property increases sufficiently to give you an equity cushion. And that can take several years.

Use the 3% mortgage as a last resort only. It’s always better to make a larger down payment if you can. And if you can’t, and 3% is the largest down payment you can afford, then make sure that the house is a comfortable fit in your budget. That means that you should focus on buying less house than you can actually afford.

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And once you are in the property, you will need to become a committed saver. You will need to increase your cash reserves steadily to provide the cushion that the missing home-equity isn’t available to provide.

What are your thoughts on the 3% mortgage? Is it good for home buyers and for the market? Or is it a return to a dangerous strategy?

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