Can you buy a home with nothing down? FHA has zero-down loan

The program requires a downpayment plan in the form of a second loan.

By JEFF LAZERSON | jlazerson@mortgagegrader.com | MortgageGrader.com | November 27, 2023

Article originally posted in Orange County Register on November 24, 2023.

Are you ready to say “so long” to renting?

Home prices are high. Mortgage rates are high. But many more homebuyers are on the sidelines. I’ve found a financing tool that might help. It’s an FHA zero-down loan program. But it comes with some asterisks.

Most first-time homebuyer programs are wrought with untenable restrictions for too many, putting many well-intentioned programs out of reach. For example, they often come with income caps or the buyer is restricted to certain areas also known as census tracts. A pretty common restriction says a buyer cannot have owned a property in the past three years.

I found a Federal Housing Administration program that offers a zero-down loan, which is particularly beneficial for renters who want to get on the road to homeownership.

The program does not have income caps or census tract limitations. The lowest middle FICO score on this particular program for all borrowers is 600. Non-occupant co-borrowers also are allowed to boost the buyer’s qualifying income. Applicants also don’t have to be a first-time buyer and they can even depart the residence, sell it or rent it and move up.

The only restriction is that the loan cannot exceed the FHA conforming limits which are $726,200 in Los Angeles County, Orange County and San Diego County. For the Inland Empire, the limit is $644,000. And by the way, those maximum loan limits will likely rise on Jan. 1.

The FHA does, however, require a down payment of 3.5%. To help the borrower with that sizeable cash payment, the program uses a second mortgage with a 10-year term to fund the down payment. The down payment second loan provides a note rate 2% higher than the first lien mortgage rate.

So, let’s run the numbers:

Take a $650,000 sales price with 3.5% down ($22,750). The base loan amount is $627,250. We add the upfront FHA mortgage insurance premium of 1.75% to the base loan for a total loan of $638,227. Assuming a 30-year FHA fixed rate also charges 0.55% for monthly mortgage insurance or MMI.

Assuming an FHA 30-year fixed rate at 7.625% without any loan origination points, the principal and interest payment is roughly $4,518.

Then add $287 which is the MMI of 0.55% (calculated on the $627,250 base loan amount).

Next, add $298 for the 9.625% second mortgage (the 10-year down payment loan).

Then add monthly property taxes of $677 based on a property tax rate of 1.25%.

Finally, add roughly $160 for monthly fire insurance, based on 0.3% of the loan amount.

The total payment is $5,940.

Closing costs and upfront required escrow impounds for property taxes, homeowners’ insurance and mortgage insurance will be roughly $9,000. (Remember: Closing costs are separate from the down payment.)

Others (home sellers and real estate agents willing to shave money off their commission, for example) are allowed to contribute up to 6% of the sales price or $39,000 (assuming a $650,000 sales price) for the buyers’ closing costs, escrow impounds, mortgage rate buydowns and the like. Closing cost buyer credits must be negotiated between the buyer and seller (typically the buyer’s agent and the seller’s agent).

Conceivably, you can buy a home with little or no money out-of-pocket.

Yes, that’s a big payment. So, how do we get it a bit lower? Beyond adding a roommate or two, mortgage rate buydowns also could help ease the mortgage payment sticker shock.

For example, a 2-1 buydown (assuming the example above) means a first-year payment based on a 5.625% rate, a second-year payment based on a 6.625% rate and years 3 through 30 at the 7.625% note rate. The total year-one payment would shrink to $5,096. The year-two payment grows to $5,509. And years 3-30 is back to $5,940.

The year one buydown savings/cost is $10,128 ($844 x 12 months). The year-two buydown savings/cost is $5,172 ($431 x 12 months). The total buydown savings/cost is $15,300.

Assuming $10,000 in settlement and impound charges and $15,300 for temporary buydown costs brings a total of $25,300. This is 3.9% of the sales price. It’s well within the 6% allowable credits.

Let’s say mortgage rates come down before the impounded buydown funds are all used. Obviously, you’ll want to refinance your high FHA mortgage note. Impounded buydown funds are the borrower’s money to be used as a credit against what is owed on the first mortgage when refinancing.

For example, assume a $625,000 mortgage balance with $5,000 left of buydown funds. The net effect is you will owe the payoff lender $620,000 on the first mortgage and whatever the amortized balance is left on the second.

The opportunity to consider buying now (or buying up) is that more homes and condos are coming on the market now.

As I wrote earlier, property prices and mortgage rates are very high. So, buyers aren’t stampeding to buy like they have over the previous four years.

On top of that, the holiday season is the slowest sales cycle of the year. Waiting until rates come down further, say to 6% from its current 7% rate range, will undoubtedly mean another stampede of buyers to compete with — along with the likelihood that home and condo prices will spike again.

No matter what, make sure you can afford the monthly payment — even if you can finagle a zero-down and zero-cost type of purchase. Make sure your income will grow into the payment and do consider some form of a rate buydown. Don’t assume rates will drop and you can refinance into a more affordable payment. There is no guarantee.

Plenty of people lost their homes during the Great Recession from variations of nothing-down loans. While FHA mortgages don’t have any predatory payment increase triggers, we’re still talking zero down.

Zero down is a great opportunity for every would-be homeowner who can afford it.

Freddie Mac rate news: The 30-year fixed rate averaged 7.29%, 15 basis points lower than last week. The 15-year fixed rate averaged 6.67%, 9 basis points lower than last week.

The Mortgage Bankers Association reported a 3% mortgage application increase compared with last week.

Bottom line: Assuming a borrower gets the average 30-year fixed rate on a conforming $726,200 loan, last year’s payment was $345 less than this week’s payment of $4,974.

What I see: Locally, well-qualified borrowers can get the following fixed-rate mortgages with one point: A 30-year FHA at 6.25%, a 15-year conventional at 6.375%, a 30-year conventional at 6.75%, a 15-year conventional high balance at 7% ($726,201 to $1,089,300), a 30-year high balance conventional at 7.125% and a jumbo 30-year fixed at 7.125%.

Note: The 30-year FHA conforming loan is limited to loans of $644,000 in the Inland Empire and $726,200 in San Diego, LA, and Orange counties.

Eye catcher loan program of the week: A 15-year conforming fixed rate mortgage at 5.875% with two points cost.

Jeff Lazerson is a mortgage broker and president of Mortgage Grader and Lazerson Learning. He can be reached at 949-334-2424 or jlazerson@mortgagegrader.com. His website is www.mortgagegrader.com.

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* Specific loan program availability and requirements may vary. Please get in touch with your mortgage advisor for more information.