No Money Down Loans - Why You Don't Want One

You may not want this loan anyway...

It may sound like a good idea to buy a home with no down payment. It’s hard to save for a large down payment, and it’s scary to part with that money after you managed to save so much. No money down loans would seem to be a solution, but they’re hard to find and often a bad choice.

What it Looks Like to Put No Money Down

How is it possible to buy a home with no money down? You generally have to get creative.

One of the most common approaches used before the financial crisis was the 80/20 loan (or “piggyback” loan). You’d borrow 80% plus 20% -- therefore 100% -- of a home’s purchase price.

The 80% loan is very similar to a loan that most homebuyers use when they make a down payment: a plain-vanilla loan like a 30 year or 15 year mortgage (fixed rate or ARM). Where does the other 20% come from? It’s a second mortgage that you apply for simultaneously with your first (80% mortgage).

No More No Money Down

Nowadays, it’s hard to buy anything with no money down. Since the financial crisis, lenders are averse to taking on that risk and allowing you to do so. It was fine in the past when they assumed that home prices would only rise, but now everybody knows that losses are a real possibility. If you don’t pay the loan off, they’ll foreclose and have to sell your home. They need to sell it for more or less what you paid (it costs money to foreclose and sell a home), and that’s not always possible.

You may still be able to buy a home without a down payment. A few programs, such as VA loans, still exist. FHA loans, and even conventional lenders, may also allow you to buy with a relatively small down payment.

Is this a Bad Thing?

It’s probably no tragedy that these loans are a thing of the past; you’re better off without them.

They’ve caused headaches for lenders, but they’ve also caused plenty of heartache for borrowers.

No money down loans result in higher interest costs -- the price you’ll pay over the life of your loan -- because you’re paying interest on 100% of the purchase price. What’s more, second mortgages generally have higher interest rates than first mortgages, so you’re paying a premium to borrow the extra 20%. Yes, it is possible to refinance or pay the second mortgage off early, but it’s easier said than done.

To see how interest costs change when you borrow more, run some numbers with a loan calculator.

In a similar way, buying a home or car with no money down means you’ll have higher monthly payments. If you can’t save money for a down payment, is a higher monthly payment in your best interest? These loans allow you to get the purchase done today, but you have to deal with the consequences for years to come.

Finally, you may have to pay for private mortgage insurance (PMI) when you have less than 20% equity in your home (in other words, when you’ve borrowed more than 80%). This extra monthly expense will add thousands or more to your total lifetime cost and it further increases your monthly payment.

Essentially, you’re taking a big risk when you buy with no money down. Your income needs to stay the same or increase and your home needs to increase in value more quickly than you bleed cash (who doesn’t believe those things will happen -- but how many people have been proven wrong)?

Is it Always Wrong?

Does this mean you should never buy a home with no money down? Not necessarily -- but they are often misused and abused. If you evaluate all the alternatives, you may find that it makes sense to skip the down payment. However, you need a solid (as opposed to hopeful and optimistic) long-term plan that allows you to pay off the loan in good times and bad.