Fannie Mae has conducted national surveys regarding the obstacles potential home owners have to overcome when trying to purchase their first home. The findings showed that there are many obstacles to home ownership ranging from credit to income, yet, there is no obstacle more important than finding the cash necessary to close.
The cash necessary to close is comprised of these components–
- Down payment
- Closing costs
- Reserves required after closing
Rules adopted after the recession have generally made it tougher from a cash perspective. Before the recession, just about anyone could find a loan program that would enable one to purchase with no money down. Programs were available for those with poor credit and whose incomes could not be verified. Now, there are very few no down payment programs available and most of the programs remaining service very specific segments of the population such as veterans and rural housing.
Most programs require at least a five percent down payment and together with closing costs and required reserves, might result in the need for $15,000 or more on a $200,000 home purchase. Coming up with that much cash is a hardship for many Americans, especially with the economy contracting.
We are here to tell you that a long-standing governmental program is proving to be the answer for many Americans in this market. The Department of Housing and Urban Development (HUD) houses an agency called the Federal Housing Administration which insures mortgages made by lenders. Why is FHA so important? Let’s just look at the cash requirements–
Lower down payment. The required down payment on an FHA loan is 3.5%, instead of 5.0%. That is a savings of $1,500 on a $200,000 purchase price.
Alternatives to coming up with the down payment. FHA not only requires a smaller down payment than most, they also are more liberal as to “where” the potential purchaser can come up with the cash–
Gifts. One hundred percent of the required cash can come from a gift from a relative or someone with a “family-type” relationship. Most other programs allow gifts, but may require that the purchaser have a certain percentage of his/her own money in the deal.
Grants from Governmental Agencies. FHA did tighten its requirements which had previously allowed the down payment to come from non-profits that collected the money from the seller. However, grants and loans for the down payment (and closing costs) are still allowed from government agencies. States and some localities have agencies that are authorized to raise money by selling non-taxable bonds under the Federal Bond Subsidy Act. This money can be used to provide below interest loans to finance real estate outright or grants for cash to close.
Closing costs. The most popular alternatives for funding closing costs include–
Seller Contributions. Especially in a buyer’s market, many sellers are willing to pay closing costs to entice a purchaser to buy their home. FHA again is more liberal than most programs in this regard. FHA allows the seller to pay up to 6.0% of the sales price towards closing costs. Many other programs cap this contribution at 3.0%. This means that the seller can typically cover all closing costs.
Lender rebates. Using a slightly higher interest rate, the lender can also sometimes use a “rebate” or “yield spread” to pay closing costs. This rebate is made possible because the higher rate brings a better price when the loan is sold on the secondary markets. FHA allows the lender to pay all closing costs in this way.
Reserves. Many loan programs require that the purchaser have up to two month’s payments in reserve after closing. FHA does not have such a requirement if their automated underwriting systems accepts the loan and it does not need a manual review from the underwriter. However, that does not mean that having money left is not a good idea. It is always a good idea to have cash available as a “cushion” after closing.
How much cash can you save purchasing using the FHA program? On a $200,000 sales price, the requirement of $15,000 or more could be reduced to $7,000 or even less. That is a significant savings and coupled with available tax incentives could reduce your net cost close to zero!