Advantages and Disadvantages of a 1% Down Payment Mortgage

Purchasing a home has become increasingly unaffordable for many due to rising home prices and high mortgage rates. Many prospective buyers believe they need to save 8-20% for a down payment, but this isn’t always necessary. A 1% down payment can significantly ease the financial burden and make homeownership more attainable. Let’s explore the advantages and disadvantages of a 1% down mortgage.

What is a 1% Down Payment Mortgage?

Typically, the minimum down payment is 3%. In recent years, it’s been common for buyers to put down between 5-7%, or even 10-18%. So, what’s the trick?

In 2023, some lenders started offering 1% down payment options. The concept is straightforward: homeowners with a credit score usually no higher than 620 and earning less than 80% of their area’s median income qualify for the program. The buyer pays 1% of the down payment, and the lender covers the remaining 2% as a grant. This grant has no repayment requirements, providing a significant opportunity for those with limited means to purchase a home.

These loans are often compared to Fannie Mae and Freddie Mac programs like HomeReady and Home Possible, which offer flexibility for low-income or lower credit score buyers. If these 1% down programs prove successful, more lenders are likely to adopt them.

The Pros of a 1% Down Mortgage

As a relatively new lending experiment, the idea of a 1% down payment is novel for both buyers and lenders. So, before considering potential pitfalls, let’s focus on the possible benefits.

1% Program Could Benefit Multiple Generations

It’s no secret that buying a home has become increasingly difficult in recent years. Economic challenges have left many families and individuals with limited housing options. A 1% down mortgage program could benefit all generations, particularly:

Gen X: Generation X has faced numerous economic hurdles, from recessions to the Tech Boom and Bust of the '90s and early 2000s, and the Housing Market Crash of '08. This program could allow Gen Xers to downsize to a more manageable home with a lower down payment, providing security as they approach retirement.

Millennials: Burdened by student debt, market crashes, recessions, and soaring home prices, Millennials have found homeownership challenging, if not impossible. A 1% down mortgage program could finally make it feasible for many to purchase their first home.

Gen Z: The youngest homebuying generation is benefiting from shifting rules in their favor. With less stringent down payment requirements, 1% down mortgage plans, and programs like HomeReady and Home Possible, Gen Z is finding it easier to buy homes despite economic turbulence.

Maximizing Down Payment Potential

A 1% down mortgage program doesn’t have to be limited to just 1%. If buyers qualify for the program but prefer to pay 3%, the lender can still contribute 2%. This effectively turns a 3% down payment into 5%, which is the maximum for most of these programs so far.

The Cons of a 1% Down Mortgage

While there are benefits, there are also some drawbacks to consider with a 1% down mortgage:

Lenders May Cap Grants

The 2% lender match isn’t always guaranteed. Some lenders, like Rocket Mortgage and UWM, cap their matched amount at $4,000. If you’re buying a home priced over $200,000, you might start with less home equity.

Risk of an “Underwater” Home

An “underwater” home is one where the property is worth less than the loan amount. This can occur if property values drop significantly while you still owe most of your loan. Smaller down payments increase this risk because you have a larger loan balance to pay off, plus interest. While being underwater isn’t always catastrophic, it can be problematic during economic downturns like the 2008 housing crisis.

Buyers Should Do Their Research

Research is essential in any homebuying process, but the real risk lies in the details. One percent down mortgages are still rare, and while they might seem like an easy way to buy a home, they may not always be in your best interest. Ensure you’re getting a competitive rate and reasonable closing costs to fully benefit from the program.