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100% FINANCING . . . IS IT A GOOD IDEA?
There can be a number of reasons why a borrower might consider 100% financing when purchasing a home. While the most obvious reason is a shortness of cash, there can be other reasons for wanting to use 100% financing.
A borrower may want to avoid liquidating other assets, like stocks or a 401k account, to acquire a down payment. Perhaps a borrower wants to leverage his/her purchase in order to maximize their tax deduction advantage? In some cases, a borrower may want to purchase a home prior to selling their present home, resulting in a temporary shortage of cash with which to purchase.
On the other hand, there are those borrowers who look to 100% financing simply because they have no financial assets. Too often, these same individuals possess less than perfect credit.
Lenders who offer 100 percent financing typically require nearly impeccable credit. Acceptable credit will be determined via a borrower's credit score, a numerical score derived from an analysis of numerous variables from a borrower's credit file. Items that affect one's credit score include the amount of outstanding debt, late payments, unpaid collection accounts, number of recent inquiries for new credit, etc. (see Tip Sheet entitled "Credit Scoring" for more information) The higher the score, the more likely an applicant will repay a loan on time, according to the system. Lenders willing to allow 100% financing, often require a minimum credit score in the 700 range. Scores below this level can make the borrower ineligible for 100% financing or, at the very least, require higher interest rate and terms.
Another focus for lenders making these high balance loans is the amount of "reserves" that a borrower will have at the close of escrow. In other words, even though no down payment is required, a borrower must generally have sufficient assets available to cover closing costs and between 2 and 6 months of reserves (i.e.; one month's reserves equals the principal, interest, taxes and insurance payment for the new loan). Many other qualifying requirements remain the same regardless of the amount of the loan request.
Many prospective buyers are dismayed to learn that the interest rates involved in 100% financing can be very unattractive. There are one loan, 100% options for borrowers with interest rates, depending upon credit scores, ranging from 7% to 9% But, in many cases 100% financing is achieved by combining a first mortgage of 75 or 80 percent of the purchase price with a 20 to 25 percent second mortgage. The interest rate on the first mortgage is likely to be between 6.5 to 8.75 percent, depending upon credit scores. The second mortgage, again depending upon credit scores, can vary between 7.5 to 10.5 percent. Additionally, the higher interest rates require higher incomes for qualification purposes. In some cases, a prepayment penalty may accompany the loan should the loans be paid off in less than two or three years. 100% loans can be pre-approved nearly instantly via automated underwriting . . . no waiting to see if a borrower is approved.
In the final analysis, 100% financing often sounds attractive but is generally disappointing to the borrowers who explore it's realities. As mentioned above, there are some very good reasons to seek this kind of financing, but for many borrowers just trying to find a way to purchase with little or no down payment, this option is probably not the best option.
If you proceed with this kind of financing, be certain that you understand all aspects of the loan you will be acquiring. Discuss it fully with your loan officer and ask questions until you are satisfied that this kind of loan will meet your specific finance need.
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