Homebuyers

Too Good to Be True? What Homebuyers Need to Know About 1% Down Mortgages

The white-hot housing market of the last several years can make saving for a down payment feel like a Sisyphean task—especially when you’re also juggling rent, car, student loan, and other payments.

That’s why some lenders have begun offering ultra-low-down payment mortgages to help homebuyers overcome this hurdle. Some of these loans feature down payments as low as 1% of the sale price of the property.

This may help more people achieve homeownership.

“There’s still people out there who think you need 20% to buy a home,” said New American Funding Senior Loan Officer Ryan Schaefer. He’s based in San Diego. “In some of these markets, especially in the coastal cities, you can’t save as fast as [home prices are] going up.”

The 1% down mortgages are different from U.S. Department of Veterans Affairs (VA) loans and U.S. Department of Agriculture (USDA loans), which don’t require any down payments. VA loans are for eligible members of the military, veterans, and their surviving spouses in some cases. USDA loans are tailored for those purchasing homes in more rural areas.

“To find [the money] for a down payment, let alone any closing costs you may incur, that’s challenging for people to come up with,” said Schaefer.

How do 1% down mortgages work? 

A 1% down mortgage may be a bit of financial sleight of hand.

After a buyer kicks in their contribution, the lender fills in the gap with grants that the buyer doesn’t need to repay, funding from down payment assistance programs which may or may not need to be repaid, or a separate loan that the homebuyer will have to pay off.  

This funding can help homebuyers in pricey areas come up with a down payment for a Conventional loan, which requires a minimum 3% of the purchase price.

It may also give buyers a financial cushion to pay down outstanding debt that might affect their credit scores or the size of the loan they may be able to secure.

Homebuyers with deeper savings receiving the assistance may also be able to purchase larger, nicer, pricier properties.

It’s also important not to forget about closing costs. Some loans will require you to cover closing costs, while others will help you to pay for them.

Schaefer noted that 1% down loans can be beneficial for buyers in hot markets, particularly for those who may be having a harder time keeping up with rising prices.

This helps them to get into a home and benefit from growing property values.

“Get into a home and let the equity and appreciation do the heavy lifting for you,” said Schaefer.

How to qualify for a 1% down mortgage

Since many of these low-down-payment loans are dependent on down payment assistance programs, there are strict requirements for who can qualify.

A typical 1% down payment loan that uses grants to help beef up your initial payment will likely have income requirements. Often, prospective homebuyers earning more than the typical resident in their area won’t be eligible for the funding.

In addition, buyers with a lot of debt may not be able to qualify for the funding. That’s because lenders look at someone’s debt-to-income ratio before approving a loan. This is how much they owe compared to how much they earn, before approving a loan.  

And like all loans, lenders offering 1% down payment products typically have minimum credit score requirements for borrowers.

Are there downsides to a 1% down mortgage?

Every choice you make in purchasing a home comes with pros and cons. Low down payment loans are no different.

If you don’t make a large down payment, you will have very little equity in your homes at the beginning of the loan. This leaves you more vulnerable to fluctuations in the housing market. For example, if home prices in your area dip a little, you could find yourself underwater on your mortgage. This means you owe more than your home is worth.

However, if you don’t plan to sell anytime soon, this gives you time for property values to rise again.

You may also be charged mortgage insurance. Typically, buyers who put down less than 20% of the sale price of the home must pay these fees rolled into their monthly payments. This protects the lender in case you stop making your mortgage payments.

Other potential drawbacks to these types of loans vary depending on their structure and the grants or additional loans used to create them.

Many down payment assistance grants come with caveats about when or even whether you can refinance your loan.

Some down payment assistance programs even require you to return a portion of the equity accrued in your home if you sell it.

Ultimately, it’s up to the homebuyer and their lender to understand what they’re signing up for and whether it’s the right choice for them.

“Be very diligent about what you’re signing up for,” Schaefer said. 

 Ryan Schaefer NMLS #847481