New homebuyers have a number of things to consider before taking on a 3% down-payment mortgage loan, from nailing down how much house they can afford to choosing the right mortgage lender and then securing a low mortgage rate once approved.
In the video segment below, The Motley Fool analysts Nathan Hamilton and Kristine Harjes talk about 3% down-payment mortgages and discuss a few important factors to consider before applying.
Kristine Harjes: One of many mortgage options that people looking at buying a home may be considering is a 3% down mortgage. And we want to tell you today exactly how you can qualify for this type of mortgage. But first, for a tiny little bit of background ... Nathan, will you tell us, what is a 3% down mortgage?
Nathan Hamilton: Yeah. So there are a few options to look at. Some traditional banks, such as Bank of America and Wells Fargo, have programs out there where you can qualify for a 3% down payment mortgage. In very plain financial terms, if you have a mortgage of $100,000, you're gonna be required to put down $3000.
Harjes: Right. And so in order to qualify for this type of mortgage, it's a little bit different than a traditional mortgage. So what are some things that you should know?
Hamilton: Yeah, there's different criteria, because banks do actually perceive it as more risky, or riskier. So the less money you put down, there are some impacts to what you're able to qualify for. So banks will say the minimum credit score is 620, but in reality, it's north of 700. If you look at actual mortgages that are approved through the banks, they're closer to 750.
Harjes: At least on average, yup.
Hamilton: Yup, on average. So don't necessarily believe the published numbers on that. And look at your credit score and realize, "Okay. Am I even close to that number?" If not, it may be worthwhile looking at different options.
Harjes: And another important thing that you should know is that you need to have a mortgage that is less than $417,000.
Hamilton: Yeah, and that's to fit within various conforming loan limits, where essentially, government-sponsored enterprises like Fannie Mae and Freddie Mac will back those mortgages, and make them less risky for banks to underwrite them.
Harjes: Exactly. One last thing that we think that you should know has to do with cash in the bank.
Hamilton: Cash in the bank, I love saying it. Yeah, just ... You've got to have cash in the bank. So if your credit score is 620, and if your mortgage is around that 417, that is stretching the limits of what you could qualify for. Now, to increase your chances of getting approved, it's a matter of showing you have financial resources to cover that payment through some other means. And many times, what a mortgage underwriter is going to look for, and say, "Okay. What is the cash in the bank? How did you source it? Did it come from income that you earned? Was it a gift, say, as a wedding gift? Did you earn it other ways?" And you actually have to go through and document exactly how you received that cash.
Harjes: Right. So it's important that you have proof of how you received that sort of cash.
Hamilton: Yup. Cash in the bank, plus proof.
Harjes: Yup. And something that is sort of a corollary to cash in the bank is your debt to income.
Hamilton: Yeah, debt to income. So this goes along the line of just good financials. If you look at what's going to affect your ability to be approved for a mortgage, a lot of it's gonna come down to FICO score, and a lot of it's gonna come down to income and debt. And a mortgage lender will generally lend you up to 43% debt to income. And what that means is, you look at your monthly debt payments, you look at your income, and the difference between those, essentially the 43%.
Harjes: And it can sometimes be hard to adjust the income part of that ratio.
Hamilton: It is.
Harjes: But the debt part of that ratio, there are definitely actionable things that you can do to change that number.
Hamilton: Yeah, I mean balance transfer credit cards are a good strategy. If you have credit card debt, you can go from paying ... You know, an average credit card APR is near 20% nowadays. You can essentially reduce that to zero percent for an introductory offer, 15 months ...
Harjes: Right, for a short-term period, anyway.
Hamilton: Yeah, 21 months with balance transfer credit cards. Then there's just lifestyle changes, which obviously are going to enable you to pay down debt quicker. Or accrue less debt in the future.
Harjes: For these and more great tips about credit scores and mortgages, be sure to visit fool.com/mortgages. And while you're there, check out our free guide called "Five Tips to Increase Your Credit Score Over 800."
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