Downsizing the down payment

REThink Real Estate

By Tara-Nicholle Nelson

12/29/2008 8:01:00 AM

Q: I just learned that I qualify for my city's first-time homebuyer's program. I thought it was a grant, but it's actually a second mortgage. Is this a good deal or not? Is there anything I need to watch out for?

A: Congratulations! The current market has presented the odd paradox for a buyer's market of having lower prices, but increased down-payment requirements. Many first-time homebuyers who would never have been able to afford a home a couple of years ago have been frustrated in their efforts to take advantage of lower home prices because they do not have a large chunk of money for a down payment. One of the last remaining sources of down-payment assistance for hard-working homebuyers are city first-time homebuyer down-payment assistance programs (DAPs) -- if you qualify for your city's DAP, kudos!

Mindset Management

Did your parents ever tell you that nothing in life is free? Same goes for money from your city to help you buy a home -- it seems like free (or cheap) money, but there are some intangible costs. Participating in a DAP adds one more party to the transaction -- another lender, really, who likely has additional restrictions and guidelines that must be followed. Incidentally, many times the DAP staffers are government employees who are burdened by bureaucracy and red tape; as such, their "piece" of your purchase transaction may take longer to get decisions, get loan commitments and get funded than the elements of your transaction that are handled by commission-paid real estate and mortgage professionals.

With that said, government DAPs are an incredible resource of down-payment funds, usually at low interest rates and on flexible and favorable terms, in an otherwise credit-crunched market. The upside is usually worth every second of added work and stress. In my experience DAP staffers will work more quickly and decisively if they are asked to, nicely, by the buyer/borrower directly (rather than only ever speaking to the buyer's Realtor and mortgage broker). It behooves you to establish and maintain a pleasant working relationship with the administrators of your DAP.

Need-to-Knows

Government DAPs have various formats. Some offer only homebuyer education and counseling. Others offer grants or actual properties for sale at a below-market price. Most frequently, though, government DAPs offer second mortgages that you can use to cover some or all of your down payment or closing costs. In a mortgage market where zero-down loans are all but nonexistent, the funds offered by government DAPs empower buyers to own homes who otherwise would not be able to buy.

How do these DAPs work? Often, the city requires prospective participants to take a homebuyer education course. Usually, the buyer must first qualify for a first mortgage from a regular mortgage lender. The vast majority of mortgages that will allow buyers to get their down payment from a government DAP are government mortgages, like FHA- (Federal Housing Administration) or state-insured loans. Fortunately, these government-insured first mortgages generally have a very low down-payment requirement, mandating as little as 3.5 to 5 percent down -- some or all of which you can get from the DAP.

The DAP/second mortgage provides you with a certain number of dollars that you can apply toward either down payment or closing costs, or both, depending on the program. I've seen them range from $5,000 to $75,000. There are some common characteristics you do need to be aware of and take into account when deciding whether to participate in a DAP:

• First-time buyer. Most programs define a first-time homebuyer as someone who (a) hasn't owned a home, (b) in the state, (c) in the last three years. That's right -- you can own a home in another state and still possibly qualify. Also, people who owned a marital home, then were divorced and haven't owned since the divorce are often considered born-again first-time homebuyers.

• Equity sharing. It is not uncommon for a DAP to require that you share some percentage of the equity you have built up when you sell the property. For example, if the DAP provides you with a 5 percent down payment, the program may require that when you sell it, you repay the DAP loan plus 5 percent of the appreciation your home experienced during the time you owned it.

• Resale restrictions. Most DAPs are designated to help low- and moderate-income households, as defined by a limit on income specified as a percentage of the average household income for your metro area, parsed out based on how many people are in the household. Some DAPs have similar resale restrictions -- you may only sell your home to someone who falls within the same income limits. This is one restriction to be really careful about -- it significantly limits the pool of prospective buyers to whom you can sell your home, and may make it much harder to get your home sold when you want or need to move on.

• Deferred or silent payments. Many DAP second loans defer payments for five or more years, so that you don't have to make any payment on the second mortgage for a good period of time. Others are actually "silent" -- you make no payment on them at all for 30 years or until you trigger another repayment event.

• Repayment triggers. Most DAP mortgages require the borrower to pay the mortgage back in full when any of the following events takes place: (1) the property is sold, (2) the property is refinanced and cash pulled out against home equity, or (3) the property is no longer owner-occupied or becomes used as an investment property.

• Low interest. Interest rates on DAP seconds are usually very favorable -- sometimes extraordinary in how much lower they are compared to market-rate second mortgages, which usually have higher interest rates than the going rate for first mortgages. Currently, many DAP second mortgage rates are running as low as 2 or 3 percent up to 5 percent. Adjustable-rate mortgage DAPs are generally tied to a buyer-friendly index and may have no added margin.

• Additional restrictions. DAPs usually add some restrictions (directly or indirectly) to the transaction -- hurdles you must leap if you are relying on a DAP for your down payment. For example, DAPs are compatible only with government-insured loans; these loans have fairly low debt-to-income ratios and have property condition requirements, so you probably can't use your city's DAP to buy a major fixer-upper. Also, many DAPs have their own condition requirements, purchase price limits, debt-to-income-ratio maximums (which may be lower than those imposed by the guidelines of the first mortgage), and requirements that the buyer put in a certain amount of money (e.g., 1-3 percent of the purchase price) from their own funds.

While these restrictions might seem burdensome, they are all imposed to ensure that buyers who use city money buy homes in good condition, and don't overextend themselves -- minimizing the likelihood you'll end up in foreclosure.

Action Plan

1. Run a search for 'Your City's Name' and 'First Time Homebuyer Program' or "Down Payment Assistance Program" to see what's available in your town. Look closely at the income limitations to get a very rough and dirty idea of whether you might qualify.

2. Ideally, select a Realtor and mortgage professional (whether a broker or an in-house lender representative) with a track record of successfully closing transactions involving city DAPs.

3. Attend your DAPs homebuyer education workshop -- you'll learn lots about real estate and mortgage basics, your particular DAP, and other information to stack the decks in favor of successfully obtaining DAP funds for your home purchase.

4. Stay involved -- make an interpersonal connection with someone at your DAP office, and maintain it -- you may need to call on it if you encounter any glitches with the DAP during escrow.

Tara-Nicholle Nelson is author of "The Savvy Woman's Homebuying Handbook," and "Trillion Dollar Women: Use Your Power to Make Buying and Remodeling Decisions." Ask her a real estate question online or visit her Web site, www.rethinkrealestate.com.

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