3 percent down mortgage options

Today’s home buyers have a wide variety of low- and no-down payment mortgage options.

You’ve likely heard of the 3.5% down FHA loan. But many first-time home buyers don’t know about Fannie Mae and Freddie Mac’s 3-percent-down mortgages.

The HomeReady and Home Possible loans are geared toward lower-income home buyers, with flexible guidelines that make homeownership more accessible.

By contrast, the conventional 97 loan is available at any income level. It’s great for homebuyers who might otherwise qualify for a loan but lack the resources — or the desire — to make a 5% down payment or more.

These 3-down mortgage loans launched a few years ago. Now, they’re among the most in-demand programs for today’s home buyers.

In this article (Skip to…)

• 3% down eligibility
• Conventional 97
• Fannie Mae HomeReady
• Freddie Mac Home Possible
• What is a 97 LTV mortgage?
• Other low- and no-down-payment mortgages
• PMI vs. FHA mortgage insurance
• 3 percent down mortgage FAQ

• Minimum credit score of 620
• Reliable income and employment
• Clean credit report (no foreclosures or bankruptcies in recent years)
• Debt-to-income ratio (DTI) under 43%, in most cases
• The home must be a ‘primary residence’ (you’ll live there full-time)
• Mortgage can’t exceed conforming loan limits; currently $548,250 in most areas
• A first-time home buyer education course may be required 
• The down payment and closing costs can be covered with gift funds and/or down payment assistance programs

Many mortgage lenders are authorized to do all three types of loans. It’s a good idea to shop around for a lender that does. Then your loan officer can help you compare requirements and rates to see which is the best fit for your situation. 

And, if all borrowers on the loan application are first-time buyers, a homeownership education course is required. (Though this shouldn’t be seen as a con, because these courses can be very valuable.)

Some home buyers choose to make a bigger down payment because it lowers their mortgage rate and monthly payments.But, a large down payment is not required.

By making a smaller down payment now, buyers can avoid rising home prices and start building home equity. The choice is up to you.

• Renter income can be counted on your application
• Income from non-borrowing occupants can count on your loan application if you’ve lived with them for at least a year
• You’re not required to spend anything out of pocket. 100% of your down payment and closing costs can come from gifted funds or down payment assistance (DPA)

The flexibility to count additional sources of income toward your mortgage qualification is almost unmatched by any other loan type.

This makes the HomeReady loan especially attractive for multigenerational households with working parents and children; home buyers who want to rent one of their rooms out; and borrowers who have a roommate but want to purchase the home on their own.

You can even use the HomeReady loan to buy a 2-, 3-, or 4-unit property and rent out the extra units for additional income, as long as you live in one yourself. But be aware that multifamily loan requirements are a little bit stricter.

Also note that the total household income on your loan application can’t exceed Fannie Mae’s limit, which is set at 80% of your area’s local median income. You can find your local median income using Fannie Mae’s Lookup Tool.

You might see these loan programs referred to as ’97 LTV mortgages.’ LTV stands for ‘loan-to-value ratio,’ a measure that compares your loan amount to your home’s market value.

In the case of a 97 LTV mortgage, your loan amount is 97% of your home’s value.

LTV is another way to talk about down payments. If a loan has a 3% down payment requirement, then the LTV possible is 97%, because you’re contributing at least 3% of the purchase price out of pocket.

Thus, the conventional 97, HomeReady, and Home Possible loans are all ’97 LTV mortgages.’  

The FHA loan has its place, though.

FHA loans require a down payment of 3.5% and you only need a FICO score of 580 to qualify.

For borrowers with credit scores between 580 and 620, an FHA loan is typically the only viable option. And home buyers with less-than-perfect credit — even above 620 — may find FHA loans to be more cost-effective than the conventional 97.

Borrowers with better-than-average credit scores, though, typically save by using the conventional 97.

VA loan

VA loans are another popular comparison product for the conventional 97.

Available to veterans and active-duty service members in the U.S. military, VA loans allow for 100 percent financing and never require ongoing mortgage insurance — only a one-time funding fee.

VA mortgage rates are typically around 25 basis points (0.25%) below rates for a comparable conventional loan, and VA loans are backed by the Department of Veterans Affairs.

USDA loan

USDA loans are a third comparison option.

USDA loans are guaranteed by the U.S. Department of Agriculture. Although they’re sometimes called “Rural Housing Loans,” these loans can be used in many suburban locations, too. The USDA’s definition of ‘rural area’ covers most of the U.S. landmass.

USDA loans offer very low rates and allow for 100% financing. They also have lower mortgage insurance rates than FHA loans and most conventional mortgages.

In short, today’s home buyers have plenty of financing options. Often the question is not “Can I afford a home?”, but rather, “Which loan is affordable for me?”

The conventional 97, HomeReady, and Home Possible loans all come with private mortgage insurance (PMI). This monthly fee — which protects the mortgage lender in case of default — is required on all conventional loans with less than 20% down.

FHA loans also come with mortgage insurance premiums (known as ‘MIP’).

So how do you know which is better?

For the right borrower, there are some clear benefits of choosing a 3-percent-down conventional loan over a low-down-payment FHA loan:

• Conventional loans do not charge an upfront mortgage insurance fee, only and annual fee (paid monthly). FHA loans charge mortgage insurance upfront annually
• PMI can be canceled once you reach 20% equity. FHA mortgage insurance typically lasts the life of the loan
• If you have a higher credit score, you get cheaper PMI rates. FHA mortgage insurance rates are the same regardless of credit

That’s not to say a conventional loan is always better than FHA. There are many cases where an FHA loan is more affordable (especially if you have low credit).

For instance, if your credit is on the low end for a conventional loan — right around 620 — and you make a 3% down payment, PMI could cost significantly more than FHA mortgage insurance.

Home buyers should consider all their low-down-payment loan options to see which one has the best balance between interest rate, upfront fees, mortgage insurance, and long-term costs.

The ‘right’ loan type will be different for each borrower.