San Jose Mercury News
Jun. 26, 2004 12:00 AM

A zero-down loan allows a buyer to purchase a home without committing any money as a down payment. Thus, if you buy a condo for $400,000, your mortgage will be for $400,000. However, you will have to pay loan-closing costs - typically, a few thousand dollars for such things as title insurance and loan fees.

Lenders also will require that you have at least a few months' worth of reserves - money in the bank or in certain types of retirement accounts or investments.

Here's a look at advantages and disadvantages of interest-only and zero-down loans.

ADVANTAGES:

• Lower monthly costs than almost any principal-and-interest mortgage. Can be a good choice for people who need or want to reserve cash.

• Allows borrowers to qualify for bigger mortgages. The lender approves your loan based on your ability to afford the monthly payment. So, if you can afford about $2,000 a month, that might get you a traditional fixed-rate mortgage of $335,000 at 6 percent, or an interest-only mortgage of $400,000 at 6 percent.

• Borrowers can pay up to 20 percent of their principal annually without penalty. That's helpful to those whose income fluctuates during the year - for example, those paid on commission.

• Potentially a good choice for buyers who plan to sell or refinance before the interest-only period ends and their payments go up steeply.

• Allows a buyer with little savings but sufficient income and credit to purchase a home. When home prices are rising, they often outstrip people's ability to save for a down payment. But by buying a home for no money down, buyers can start building equity quickly.

DISADVANTAGES:

• Monthly payments will rise dramatically after the interest-only period ends and will depend on prevailing interest rates. If you are unable to refinance the loan and don't plan to sell the home, the resulting payments might not be affordable.

• Poor choice for borrowers who want to know exactly what their payments will be after the initial interest-only period.

• Poor choice for borrowers whose goal is to gain equity by paying down their principal.

• Generally speaking, if you put down less than 10 percent toward your home purchase, your lender will require you to pay for private mortgage insurance, or PMI. PMI can add thousands of dollars to your homeownership costs over the first few years of your loan.

• Interest rates for zero-down loans are typically slightly higher because of the increased risk that the borrower will default.

• If you unexpectedly need to sell your home soon after you buy, you may have gained little equity in the home, and will have to pay closing costs and real-estate sales commissions out of your own pocket.

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