What You Need to Know About 3% Down Payment Mortgages

By Nathan Hamilton Markets Fool.com

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Home buyers have a wealth of mortgage options at their disposal. From conventional bank mortgages to government-backed offerings that can help yousecure a competitive mortgage rate, it pays to nail down the essentials to uncover which may be a fit for your needs.

With that in mind, Motley Fool analysts, Kristine Hartjes and Nathan Hamilton, discuss in the video below what you need to know about low down payment mortgages.

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KRISTINE HARJES:

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So when it comes to buying a home, one of the big decisions that you have to make is how much money to put down. Say you only want to put down 3% of the value of the house. What do you need to know?

NATHAN HAMILTON:

So you need to know you options, and looking at a few of them out there, you can look at an FHA mortgage and then, say, comparing it to a bank mortgage which some call a Conventional 97. What that means is you're loaning 97% of the value of the home, with is also the same as 3% down.

But it's worth understanding the differences between those two mortgages, because a lot is different other than the 3% down payment.

KRISTINE HARJES:

So we know that FHA loans are, in general, for new homeowners and lower-income Americans. It often requires a very small down payment, such as 3%. However, they can also be used in cases where it's slightly more than that. But in general it's for that very low down payment. What else do you need to know about them?

NATHAN HAMILTON:

And along with the low down payment, your credit score requirements are a bit lower. Banks are super stringent on the credit score, and many times even to be worthwhile applying for a mortgage, you've got to be in the mid-600's plus. With FHA, to qualify for the 3.5% down mortgage, you're going to need a credit score of at least 580. And if you put that in context of the average American's credit score, it's just below 700. So it is fairly low, and as you can see, it is an option for home buyers that maybe don't have the best credit history. Maybe don't have the right income, but still want to get a competitive rate.

KRISTINE HARJES:

So how does that compare to the Conventional 97?

NATHAN HAMILTON:

I would say the biggest thing is what they call PMI, or private mortgage insurance. And with a regular mortgage, what's going to happen is you pay this monthly insurance fee until you owe less than 80% of the value of the home. The loan-to-value ratio. But with an FHA mortgage as one of the things that compensates for the risk of you being a riskier lender to the bank, that insurance premium expands for the life of the loan.

So it is something to consider, and what many people do is you can refinance from an FHA loan to another loan once you're at that 80% or lower value to take advantage of a lower monthly mortgage payment.

KRISTINE HARJES:

Interesting. So as a decision in general, do you think opting for this 3% strategy is a smart one?

NATHAN HAMILTON:

Well, I'm going to go super legal here and say it depends upon your situation.

KRISTINE HARJES:

Of course.

NATHAN HAMILTON:

It really is what it comes down to, because for some people it does make sense, and even if you do pay PMI over the life of the term, sometimes you do get really competitive rates and it is worthwhile, and out-of-pocket costs over the life of the loan are lower.

But there are the caveats to it that there are some downsides. There are some pros and cons. I would say do your research. We have a bunch of research on Fool.com regarding mortgages, but it really does depend upon your situation and if you're willing to take that time, say five years from now, when you are in a better situation to refinance to a different loan.

KRISTINE HARJES:

As you mentioned, it is a very detailed thing to consider. It's almost unfair for me to ask for just a yes or no answer.

NATHAN HAMILTON:

Well, we'll try and give people the information.

KRISTINE HARJES:

And for even more complete information, as you mentioned we have it available on Fool.com/Mortgages. You can head there to compare rates and also get in contact with certified lenders. And you can even download some of our free mortgage guides, such as "5 Tips to Increase Your Credit Score Over 800."

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