Low-down-payment mortgage options: 3% down mortgages for first-time home buyers

Dan Green
The Mortgage Reports contributor

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.

Verify your 3-down mortgage eligibility (Jun 20th, 2021)

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3% down mortgage eligibility

Fannie Mae and Freddie Mac — the agencies that set the rules for ‘conforming loans’ — offer three low-down-payment mortgage programs.

These 3 percent mortgages open the door for home buyers who don’t have the ‘typical’ conventional loan down payment of 5% or more.

  • Conventional 97 loan — 3% down payment mortgage for first-time and repeat home buyers. No income limits
  • HomeReady loan — 3% down mortgage from Fannie Mae. Income limits apply
  • Home Possible — 3% down mortgages from Freddie Mac. Income limits apply

The main difference between these programs is their target audience.

The HomeReady and Home Possible programs are mainly intended for low-income and moderate-income home buyers, as well as intergenerational households and buyers in certain ‘minority neighborhoods.’

They have special flexibilities that make homeownership more affordable for eligible borrowers, like the ability to use renter or roommate income to help you qualify.

Both programs are available to first-time and repeat home buyers, although they’re generally geared more toward first-timers.

The conventional 97 has a wider appeal. It’s a great option for home buyers who have good credit but modest savings — or for buyers who want to make a small down payment so their money’s not tied up in real estate and they can invest it elsewhere. 

Aside from these differences, the conventional 97, HomeReady, and Home Possible have similar rules for qualifying:

  • 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. 

Verify your 3-down mortgage eligibility (Jun 20th, 2021)

The conventional 97 mortgage

Today, more and more lenders are offering the 3% down conventional 97 mortgage as an alternative to the standard 5% minimum down payment.

This loan might be perfect for you if:

  • You have good credit or excellent credit but modest savings
  • You don’t want to spend all your savings on a down payment and closing costs
  • You want to cancel private mortgage insurance as soon as you can
  • You want to buy a more expensive home than FHA loan limits allow

Unlike the HomeReady and Home Possible loans, the conventional 97 mortgage has no income limits. So it’s a better choice if you make a substantial income, or if you want to buy with a partner or co-borrower and your combined incomes would be above the allowable limit.

The conventional 97 mortgage is a bit more flexible than Fannie and Freddie’s other 3%-down options. But it still has tighter restrictions than a conventional loan with 5%, 10%, or 20% down.

For instance, you must buy the home as your primary residence. Investment properties and vacation homes aren’t allowed under the conventional 97 program.

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.

Check your conventional 97 eligibility (Jun 20th, 2021)

The Fannie Mae HomeReady mortgage

Fannie Mae’s HomeReady mortgage program is a great loan option for lower-income buyers. Some of the key benefits include:

  • 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.

Check your HomeReady eligibility (Jun 20th, 2021)

The Freddie Mac Home Possible mortgage

Freddie Mac’s Home Possible Mortgage is very similar to Fannie Mae’s Home Ready.

  • Income limits are set at 80% of the local median
  • Boarder income can be counted on your application if the renter has lived with you for at least one year
  • The full down payment and closing costs can come from gift funds or down payment assistance (DPA)

A key difference, though, is that Freddie Mac will count only renter income toward your application. The income of other household occupants, like family members and roommates, can’t be considered.

Like Fannie Mae, Freddie Mac allows borrowers to purchase a 2-4 unit property with 3% down, as long as the homeowner lives in one of the units full time.

What is a ’97 LTV mortgage’?

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 maximum 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.’  

Other low-down-payment and no-down-payment mortgage options

With the introduction of the Conventional 97 home loan, the U.S. government is making it easier for potential buyers to become homeowners.

Fannie Mae and Freddie Mac join the FHA, VA, and USDA in offering low-down-payment loans to buyers nationwide.

FHA loan

The conventional 97’s attractive terms have helped it grab market share from the FHA loan, which is another popular low-down-payment option backed by the Federal Housing Administration.

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 most affordable for me?”

Check your home loan options (Jun 20th, 2021)

Private mortgage insurance (PMI) vs. FHA mortgage insurance premium (MIP)

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 and 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. 

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3 percent down mortgage FAQ

Can I get a mortgage with 3% down?

Yes! The conventional 97 program allows 3% down and is offered by many lenders. Fannie Mae’s HomeReady loan and Freddie Mac’s Home Possible loan also allow 3% down with extra flexibility for income and credit qualification. FHA loans come in a close second, with a 3.5% minimum down payment.

Who qualifies for a 3% down mortgage?

To qualify for a 3% down conventional loan, you typically need a credit score of at least 620, a two-year employment history, steady income, and a debt-to-income ratio (DTI) below 43%. If you apply for the HomeReady or Home Possible loan, there are also income limits. FHA loans allow a minimum FICO score of 580 and no income limits, but have a 3.5% down payment requirement.

Can first-time buyers use the conventional 97 program to purchase a home?

Yes. You can use the 3-percent-down conventional 97 loan if you are a first-timer or repeat buyer.

What is the definition of a ‘first-time home buyer’?

For most programs, you’re a first-time homebuyer if you have not owned a home within the last three years. There are other exceptions to this rule for those with homes that can’t be repaired to livable standards, those with mobile homes (personal property), and others.

Is the conventional 97 the same as the HomeReady program?

No, these are two different mortgage programs. The HomeReady loan is aimed at applicants who meet income eligibility guidelines, putting them in the low or moderate-income categories. The conventional 97 has no income limits and is more widely available.

Are down payments larger than 3 percent allowed with the program?

There is no limit to the size of your down payment with a conventional loan. Although if you put down 5% or more, you will no longer be using the conventional 97 mortgage, but rather a ‘conventional 95’ loan. With 10% down or more it’s just a ‘standard’ conventional loan. The bigger your down payment, the lower your interest rate and monthly payments.

Is the 3-down mortgage via Fannie Mae and Freddie Mac better than an FHA loan?

There is no “best” low-down-payment mortgage program. What’s best for one home buyer may not be what’s best for another. Each program has its benefits and drawbacks. To find the right program you should compare interest rates, mortgage insurance rates, upfront fees, and interest paid over the life of the loan. Consider how long you’ll stay in the home and how much you want to pay upfront.

Can I use an adjustable-rate mortgage (ARM) with the conventional 97?

No, the conventional 97 does not allow adjustable-rate mortgages, only fixed-rate mortgage loans with terms ‘up to 30 years.’

What is the loan limit on the 3 percent down program through Fannie Mae and Freddie Mac?

Conventional loans with 3 percent down must meet Fannie Mae’s standard conforming loan limit of $548,250. ‘High-balance conforming loans,’ those with higher loan limits in expensive areas, are not allowed under the conventional 97 program.

What is the maximum number of units for a home under the 3 percent down payment program?

The conventional 97 program allows only single-family primary residences (meaning a one-unit house, condo, or co-op). However, the 3%-down HomeReady and Home Possible loans allow 2-, 3-, and 4-unit properties.

Are vacation homes eligible under the conventional 97?

No, the 3 percent down payment program is for primary residences only. You’ll need a different loan for vacation or second homes.

Can I use the conventional 97 for investment properties?

No, the 3 percent down-payment program is for primary homes only. You can’t finance a rental or investment property with this product.

Does the conventional 97 mortgage program require home buyers to attend home-buyer counseling?

If all borrowers on the mortgage application are first-time home buyers, at least one borrower will need to attend an online home buyer education course.

Does the conventional 97 require mortgage insurance?

Yes, mortgage applicants must pay private mortgage insurance (PMI) premiums. However, unlike FHA loans, conventional PMI can be canceled once the homeowner has at least 20% home equity.

Can I refinance a non-Fannie Mae loan with Fannie Mae under the 97 percent LTV program?

No, the loan you refinance must be a Fannie Mae home loan.

How do I determine if my loan is a Fannie Mae mortgage?

To determine if Fannie Mae backs your current loan, ask your lender or use Fannie Mae’s online loan lookup tool.

Does the 97 percent mortgage program allow cash-out refinancing?

No, the 97 percent mortgage program does not allow cash-out refinances. Borrowers may do a cash-in refinance or a “limited cash-out” refinance only.

3-percent-down mortgage rates

Today’s mortgage interest rates are at historic lows. That includes rates for conventional 97, HomeReady, and Home Possible loans.

A low-down-payment mortgage paired with a low interest rate can make homeownership more affordable than you might have expected.

Check your rates and eligibility today to see what you can afford.

Verify your new rate (Jun 20th, 2021)