Underwriting guidelines change all the time. But interestingly, one thing that is somewhat constant is the amount of down payment due at the closing table. Many borrowers find, however, that coming up with the cash for the down payment has perhaps been the biggest obstacle to homeownership.
Seventy-five years ago, banks would only loan money to buy a house if the homebuyer had 30 percent or more of the sales price for the down payment. Even in 1935 when the average price of a home in the United States was $3,400, coming up with $1,000 for a down payment was a challenge. After all, the average income of a worker was just $1,500 per year. But in the 1930s the government decided to step in and help Americans buy their homes, and the Federal Housing Administration (FHA) was created to offer prospective homeowners the opportunity to buy a home with a small down payment and a stable 30 year fixed rate loan.
Today, our government, through the FHA, insures lenders who offer FHA loans. These loans have many benefits but probably the most noteworthy is that FHA insured loans allow a homebuyer to buy a home with as little as 3.5 percent down and to borrow as much as $729,750 (in a high-priced housing market) at a competitive 30-year fixed rate. FHA loans are typically more lenient on credit and allow a borrower to spend more of their monthly income on their house payment than conventional loans. They also allow a borrower to receive all of the down payment as a gift.
But FHA-insured loans also have their downsides. For example, FHA loans require mortgage insurance on every loan, despite the size of the down payment, and that mortgage insurance effectively adds up to 1.35 percent to the note rate. In other words, if the 30-year fixed rate today were 3.25 percent, the effective rate for an FHA loan would be over 4.5 percent.
Alternatively, the conventional financing offered by Freddie Mac and Fannie Mae requires the borrower to pay for mortgage insurance only if there is less than 20 percent for the down payment. Mortgage insurance may be paid either on a monthly basis or as a lump sum at the close of escrow. The precise payment options are dependent on the loan to value ratio, the loan amount and the credit score. Unlike with the current FHA loans, mortgage insurance on conventional loans does not continue throughout the life of the loan.
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