With banks and traditional lenders still reeling from the financial fallout caused by their lax lending standards, the Federal government has stepped in as the backstop lender of choice for buyers with less than the standard 20% downpayment. Â Currently, the FHA (Federal Housing Administration) provides insured loans for nearly a fifth of new loans and can still qualify buyers with only 3.5% downpayment at lending standards which are looser than those of conventional lenders. Â
There is a cost of course. Â Even though buyers often see the headline interest rates of FHAÂ insured loans as being the same or sometimes lower than conventional loans, FHA mortgage insurance (MI) adds a premium of 1.15% to regular monthly mortgage payments. Â This MI needs to be paid for 5 years or until refinanced. Â This is on top of an upfront fee to FHA of 1% of the purchase price. Â For those with insufficient downpayments and a strong desire to buy a house in the middle of a historic housing price correction, FHA insured loans are a relatively cost-effective solution. Â For the buyers who can see beyond the current distress, the potential price appreciation going forward should outpace the additional cost of financing.
As a comparison, those buyers can also check out PMI (Private Mortgage Insurance) options for downpayments as low as 5%. Â Similar to FHA mortgage insurance, PMI adds to financing costs each month but does not require an upfront payment. Â For those with solid credit score of above 750, the cost of PMI is very comparable to FHA
. Â The trade-off being that PMI backed loans may have less restrictive terms than FHA, allowing the borrower to refinance to cheaper loans sooner when the necessary cash is available. Â So, for those with a bit more cash and good credit, PMI is a better option. Â But for those with lower credit scores of around 650, FHA often ends up being cheaper.
A third option is possible -- private lenders. Â Traditionally referred to as hard money lenders, these sources of financing have stepped in to fill the financing gaps left by FHA and conventional lenders. Â For target properties that don't meet traditional underwriting standards, private lenders can provide financing of up to 50% (sometimes higher for specific properties)Â of the purchase price. Â The interest rates charged can be very steep, typically around 10-12% with a stiff origination fee of up to 4 points. Â This high cost of financing reflects the current high level of demand for private capital. Â So, while this option doesn't appeal to most people, buyers who go this route have often secured properties at significant discounts to the market (15-50% below), justifying the costs. Â
Finally, there's a range of other creative financing options, which are available depend on the unique situations of each individual buyer. Â