Zillow Home Loans is the latest lender to roll out a 1% down payment option to first-time homebuyers, who are getting shut out of the housing market due to soaring mortgage rates.
The housing affordability crisis is three-fold. Mortgage interest rates are the highest they’ve been in over two decades (above 7%), home prices remain stubbornly high and housing inventory is low. Present-day homeowners are reluctant to sell since it would mean giving up low borrowing rates they locked in previously.
Many prospective buyers have been unable to save for a 20% down payment -- the suggested amount by lenders -- and are waiting for mortgage rates to go down and inflation to cool before purchasing a home. In the face of declining home sales, Zillow and other lenders, such as Rocket Mortgage and United Wholesale Mortgage, are offering up 1% down payment options to attract new homeowners.
The main advantage of a 1% down payment is that you can buy a house faster without having to wait to save up more cash, according to Bernadette Joy, founder of Crush Your Money Goals. But a smaller down payment means a heftier home loan amount, which translates to significantly higher monthly payments. Taking on greater debt could cause problems down the road if the economy remains volatile or the job market slumps.
Saving for a down payment is one of the main hurdles for would-be buyers. Before accepting a 1% down payment offer, take some time to explore your options, including government-sponsored or private programs (detailed below) that can assist with your down payment and closing costs.
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How Zillow’s 1% down payment program works
According to its press release, the Zillow Home Loans program is geared toward first-time homebuyers who have enough income to afford higher monthly payments, but don’t have enough for a large lump-sum down payment. Right now, the program is only available to new buyers in Arizona, but Zillow says it has plans to expand to other states.
“Homeownership is how most Americans make and keep their wealth,” said Orphe Divounguy, senior macroeconomist at Zillow. Divounguy explained how people can benefit from purchasing a home over renting, which has become more expensive: “Rents increased by 31% during the pandemic, so you have prospective buyers already paying more in rent than they would for their monthly mortgage payment.”
Zillow Home Loans’ new offer is essentially a 2% grant, said Divounguy. Buyers will put down 1% of the home price, and the lender will contribute an additional 2% at closing. That brings the total down payment to 3%, which is the minimum amount required for loans backed by Fannie Mae and Freddie Mac.
For example, a 1% down payment on a $400,000 house would be $4,000. With the 2% contribution from Zillow, you’d have a 3% down payment equal to $12,000.
Who qualifies for the program
To qualify for the 1% down payment program, borrowers must meet a few requirements, according to a Zillow representative:
- Be a first-time homebuyer (have not owned a home in the past three years)
- Have a minimum credit score of 620
- Have a debt-to-income ratio no higher than 50%
- Earn an income below 80% of the area median income where the property is located
- Intend to live in the property as the primary single-family residence
- Complete a first-time homeowner education course
The pros and cons of low down payments
Traditionally, experts have recommended budgeting 20% for a down payment to reduce the amount of money you have to borrow and the interest you’ll accrue on the loan over the years. But affording 20% upfront can be cost-prohibitive for many cash-strapped households, and it’s not a requirement. In fact, the median down payment for first-time homebuyers is 6%, according to the National Association of Realtors.
It might not be worth draining your savings account to cover a 20% down payment if you plan to do home renovations, need to cover an appraisal gap or want to invest the cash elsewhere. What’s more, waiting to save for a larger down payment could mean you miss out on months or years of building equity.
While a low down payment is attractive for buyers struggling to contend in today’s housing market, it comes with significant trade-offs. When borrowers take on more debt to finance their home purchase, they’ll have higher monthly payments. Having a more expensive monthly payment could increase the risk of missing payments or defaulting on the loan, which could eventually lead to foreclosure.
In addition, putting down less than 20% almost always requires you to pay private mortgate insurance until you reach 20% equity in the home, which can add hundreds of dollars to your monthly mortgage payment.
Another pitfall of low down payment is that you’ll have very limited equity, leaving you vulnerable to going underwater on your mortgage. If you only put down 1% of the cost of the house, and property values decline, your house could end up being worth less than what you owe on it. This can limit your ability to sell or refinance the property in the future.
Here are some of the pros and cons of a low down payment:
Pros
Afford to purchase a house faster
You won’t need to deplete your savings so you can free up funds to cover expenses such as closing costs
Buying sooner means you can start building equity as opposed to just paying rent
Cons
Larger loan amount means higher monthly mortgage payments and interest paid
Risk of negative equity (owing the bank more than what your home is worth) if property values drop soon after you purchase a house
Have to pay private mortgage insurance
Buy what you can afford
Regardless of your down payment, it’s important to determine if you can comfortably afford your monthly mortgage payments and have enough savings to cover the unexpected expenses that come with homeownership.
A good way to know if you can afford mortgage payments is to look at your debt-to-income ratio, which shows what percent of your income goes to debt each month. You can calculate it by dividing your total monthly debt payments -- including your estimated monthly mortgage payment -- by your monthly income before taxes.
While a lender may preapprove you for a loan amount higher than your budget, it may not be best to use all your buying power. Zillow’s 1% down payment program has a maximum debt-to-income ratio requirement of 50%, but a good rule of thumb is to keep your DTI below 36%. So, if you take home $6,000 a month, you’ll want to keep your monthly debts, including your estimated mortgage payment, under $2,160.
“There’s a lot of hurdles to overcome if you want to buy a home with a large down payment, so if you choose to buy without one, there’s no shame in that,” Joy said.
But rather than simply opting for the lowest down payment, Joy recommends trying out different down payments, prices and mortgage rates in a calculator to see how much you can really save yourself in the long run.
To get a good idea of what your monthly mortgage payment will look like, you can use CNET’s mortgage calculator.
Other options for homeownership
Before rushing into a new down payment offer, it’s helpful to explore government-sponsored and private programs that provide assistance through grants, low-to-no interest loans or forgivable loans.
Read more: These 8 First-Time Homebuyer Programs Can Save You Money on Your Mortgage
In order to qualify for assistance, you may need to meet criteria, such as income limits or first-time homebuyer status (not having owned a home within the last three years). Not all down payment assistance programs are accepted by every lender. If you’re eligible, you’ll want to work with a participating lender.
Nearly all down payment assistance programs are local. You can find programs by doing a quick Google search, reaching out to your state or local housing authority or speaking with your realtor or lender.
If you can’t find or qualify for financial aid, you may opt for a loan backed by the federal government, which usually has a lower down payment requirement.
- FHA loans: Insured by the Federal Housing Administration, an FHA loan is a mortgage issued by an FHA-approved lender intended for borrowers with low to moderate income. An FHA loan allows for a small down payment (as low as 3.5%) and has lower minimum credit score requirements (580 or above) than most conventional loans.
- USDA loans: Those looking to buy in certain rural areas may be eligible for a loan from the US Department of Agriculture. USDA loans are guaranteed loans that offer 100% financing, meaning no down payment, to borrowers with moderate to low income who purchase homes in eligible areas. Offered by nationally approved lenders, USDA loans typically have a minimum credit score of 640.
- VA loans: Veterans, active service members and qualified surviving spouses are eligible for loans through the US Department of Veterans Affairs. VA loans are offered by private lenders and oftentimes, a down payment and mortgage insurance are not required. However, you’ll need to pay an upfront funding fee unless you qualify for a waiver.
The bottom line
High mortgage rates are preventing would-be buyers from purchasing homes. Zillow’s 1% down payment program is trying to attract new owners in an unaffordable housing market. But before committing to a lower down payment, consider if you can actually afford taking on more monthly debt in a high-interest environment and if the long-term trade-off is worth it. Experts recommend you take the time to explore other options first.
