Why You Shouldn’t Get A No Equity Home Loan

home_valueAre you looking to get a loan but have no money to put down for the purchase?  You may have considered a no equity home loan however you may not be aware of the risk that go into getting a loan like this.

In this article I’m going to show you 3 big reasons why you don’t want to get a home loan with no equity in it, and hopefully by the end this article I will give you a couple of other options you try instead of going with the no equity home loans option.

PMI Insurance

First off, home loans with no equity will add some extra fees to your mortgage than if you’d have actual cash down, and one of those fees is PMI insurance.  PMI insurance or also known as private mortgage insurance is an insurance that protects the lender from defaulting on riskier loans.  This fee isn’t tacked onto ever mortgage just the ones that have less than 20% equity in the home.

For example if you would have a $200,000 mortgage with a 6% interest rate, 30 year fixed, you would pay around $180 a month extra on your mortgage.  If you carried this the entire life of the loan you would pay close to $65,000.  That’s a lot of money.

Finally, one other thing I should mention here is if you do plan to get this type of mortgage you should know that lenders won’t cut off the PMI insurance just because you have more than 20% equity in the loan.  You will have to call the lender personally and have them remove the PMI manually.

If The Value Would Drop

The next big problem you will have with getting a mortgage like this is if the value drops on your home.  In 2008 and 2009 home prices dropped dramatically around the country.  In fact many people couldn’t sell their homes as a result.  In places like Dayton, Ohio some people were force to abandon their homes altogether.

For example, if you would get a $200,000 mortgage and the value of the home would drop by 5% your home value would only be worth $190,000.   This means you would now owe $10,000 more on the property than it was worth.

To complicate matters more it would make it much harder to sell.  The reason being one that you are in a soft market where the buyers just are not available and two in order to sell the property you would have to have the extra $10,000 paid back on the loan.  If the value of the property exceeds 100% loan to value lenders won’t finance it.

Higher Interest Rates

Finally, if you decide to go this route you will face higher interest rates with your loan.  In fact people with 20% down and good credit could get a 30 year fixed mortgage for around 4.875%.  However if you got the same mortgage with nothing down you would end up with something around 7%.

For example lets say you had a property with a $200,000 and put 20% down, you would have loan for $160,000 and rate of 4.875%.   With this mortgage you would have a payment around $850.  On the other had if you got a no equity loan and had to finance the full $200,000 with a rate of 7% you would have a payment around $1400.

This would be a $550 difference in loan payments and over the life of the loan you would pay nearly $200,000 more than if you would have equity in the home.  Obviously it makes a big difference if you have equity in you home.

Other Options You Should Consider

Finally, if have read this article you may be starting to realize why having a no equity home loan is such a bad idea.  In this section I’m going to give you a few options you can try if you would still like to proceed.

First, consider staying where your at and saving up some more money before you consider taking such a big step.  You may not be able to put 20% down for a home but their are other loans available that will let you get by with less equity in the home.  In fact some will let you get by with putting only 3% to 5% cash down.

Second, if saving money is hard to do start small and work your way up.  I recently read about a guy who was a minimalist who downsized his home to a smaller home so he could save up enough money to buy the home he wanted.

This might all seem like a bit much to take in all at once so take some time and cover all of your options and do your research before you make a decision.

Chris

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6 Comments

  1. Chris,

    I am of the opinion that if someone can’t save up at least a small down-payment (3-5% as you suggested) they have no business buying a house. In fact, I’m shocked that zero down-payment loans are even available. It’s almost as bad as a payday loan.

    I know this sounds judgemental, but it’s really just common sense. Houses need maintenance, taxes, insurance and many other costs new buyers don’t expect. The chances of someone losing a house with no down-payment are very high, which is why the PMI and interest rates are so high. If anyone thinks rent is throwing money away, try buying and losing a house.

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