Whenever a financial institution lends out money, it takes on a certain risk. Home purchases are generally considered lower risk because the real estate is used as collateral for the loan. If you can’t meet the payments, the lender will own the property.
One way that lenders minimize the risk is by requiring a certain percentage of the purchase price as a down payment. That means that the borrower has equity, and therefore something to lose, right from the beginning.
But lenders have been willing to take on more risk and lend even more than the purchase price. If the home is in an area where real estate values have been rising, the homeowner’s equity could also rise quickly. The equity you have in your home is the difference between what you owe and how much the property is worth.
There are added costs with this type of loan. The interest rates will usually be higher than if you have a down payment. Also the lenders will usually require premium insurance. This also adds to your monthly payment.
Benefits of 107% Loans
This type of loan can make sense under some circumstances. For example if you have money for a down payment but you want to make improvements to the home you are buying. It might makes sense to finance 107% of the purchase amount and then use the down payment money and the extra finance amount to work on the home. At the end of the home improvement project, you’ll have more equity because the property will be worth more.
To qualify for these types of loans, borrowers have to have good credit scores and good, verifiable, sources of income. It’s a good idea to find out your FICO score before you start home shopping. A good score could mean that you’d qualify for a larger loan.
Federal regulators have begun looking closer at these types of loans. According to the National Association of Realtors, almost 30% of all mortgages in 2005 involved some sort of zero-down financing. This could have wide ramifications in the mortgage industry if housing prices take a sharp dive. Without assets to back up the loan, a large number of defaults could threaten the stability of the industry.
Before you take out this type of loan, take some time to look at all your options. The difference in interest rates between loan with a 5% or 10% down payment and zero down could be costly in the long run.
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