You might want a small mortgage loan if you’re looking for a townhome or condominium in an affordable area. Or maybe you want to buy a single-family home in a low-cost area.
Since small mortgages aren’t as widely available as larger mortgages, you might have trouble finding lenders who offer them. We’ll explain why that is, where to look, and how to qualify.
What is a small mortgage loan?
A small mortgage loan is a home loan for less than $150,000, according to the Pew Charitable Trusts. These loans may also be referred to as small-dollar mortgages, mini mortgages, or micro mortgages.
Tip: Some lenders use the term “mini mortgage” to refer to a home equity loan, but this article is about first mortgages, also called purchase mortgages.
It’s not hard to imagine a scenario where you might want to borrow less than $150,000 to buy a home. Here are a few examples:
Why small mortgage loans are hard to get
There are several reasons why small mortgage loans aren’t as widely available as larger home loans, but one of the biggest is cost.
Less profit for lenders
Small mortgages are hard to get because they aren’t as profitable for lenders — not because necessarily they’re riskier.
The reason they’re not as profitable is that lenders have to follow the same fundamental procedures — like carefully underwriting each loan — and meet the same regulatory requirements to process most mortgages, regardless of the loan amount.
Example: A major regulatory requirement is the ability-to-repay rule. It limits how much lenders can charge borrowers in points and fees to get a qualified mortgage, like a conventional or government-guaranteed loan. The cap is either 3%, 5%, or 8% of the loan amount, depending on the loan size.
For example, if a lender can’t earn more than $3,000 on a $100,000 mortgage, but it costs the lender more than $9,000 to issue the loan, then issuing similar small mortgages will be unprofitable.
To make small mortgages profitable, then, lenders may charge higher interest rates — but they’re still limited to how much they can charge under the ability-to-repay rule.
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Non-qualified mortgage popularity
Lenders who don’t want to follow these rules have an alternative. They can offer homebuyers non-qualified mortgages (non-QM). Non-qualified mortgages don’t abide by the strict lending rules of conventional and government loans.
This gives lenders more flexibility with loan terms and allows them to decide what a borrower can afford to repay. So, if you have non-traditional income (for example, you’re a freelance worker) or poor credit, you may have an easier time qualifying for a non-qualified mortgage than a qualified mortgage.
However, this accessibility also makes non-qualified mortgages riskier for lenders, and, as a result, non-QM loans are only a small part of the mortgage market. Some lenders don’t offer non-QM loans, and those that do may charge higher fees or interest rates to compensate for the additional risk.
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Collateral value
Another problem is that less expensive homes are less valuable collateral.
The homes people want to buy with small mortgages may be located in economically depressed areas with weak housing markets. These homes are more likely to lose value and not be worth enough to cover the lender’s losses after foreclosure.
Minimum mortgage amount you can borrow
Mortgage lenders have different minimum mortgage amounts. You’ll probably have an easier time finding a small mortgage if you want to borrow at least $50,000.
Here’s a sample of different lenders and their minimum mortgage amounts:
How to find a small mortgage loan
Lenders will often list the maximum amount you can borrow to buy a home on their website, but finding a lender’s minimum mortgage amount isn’t as easy.
You might have a better chance of finding a small mortgage loan at these types of institutions:
- Credit unions
- Small community banks
- Community development financial institutions
Credit unions can be a good place to start when shopping for small mortgages. Since they’re non-profit organizations, credit unions can be more flexible with whom they loan to and offer options that more closely align with low- and moderate-income homebuyers.
Small community banks have an incentive to offer small conventional mortgages because the Community Reinvestment Act requires them to meet the needs of the areas they serve. Meanwhile, community development financial institutions are exempt from the ability-to-repay rule.
Small mortgage loan requirements
Qualifying for a small mortgage is no different from qualifying for a standard mortgage. As always, the requirements will depend on the loan type you’re applying for as well as the lender’s guidelines.
The main difference is that if you’re applying for a small mortgage, there’s a greater chance that you’re applying for a non-qualified mortgage. And when it comes to non-qualified mortgages, all the usual borrower requirements don’t apply, so lender guidelines become much more important.
Requirements will vary by lender, but here are some guidelines you might need to meet:
- Credit score: At least 500
- Income: Predicted to be stable and reliable for at least three years after closing
- Debt-to-income (DTI) ratio: No higher than 50%
- Down payment: At least 3.5%
Good to know: You’re unlikely to qualify if you only meet the bare minimum requirements for each category. Lenders typically require you to compensate for a low credit score with a high down payment and lower DTI, for example. Having enough cash reserves to cover at least three months’ worth of mortgage payments after closing can also help you qualify.
Check Out: Mortgage Closing Costs: What They Are and How to Lower Them
Small mortgage loan alternatives
If you can’t find a small mortgage, you could consider one of these options. However, they all have significant drawbacks to buying a house.
Personal loan
Personal loans are available in almost any amount, depending on the lender and what you can afford based on your income, existing debts, and credit history.
While personal loans aren’t how most people buy single-family homes, townhouses, or condos, they’re a common form of financing for mobile homes and tiny houses.
Personal loans usually have higher interest rates and shorter terms than mortgages, so you could be looking at a relatively high monthly payment.
Owner financing
With owner financing, you make payments directly to the home seller. You might be interested in this option if you don’t have good credit or enough money for a down payment — or if you can’t get a small enough mortgage even though you’re well-qualified.
If you don’t know much about the legalities and risks involved in buying a home this way, you can easily get taken advantage of. Be sure to hire an experienced real estate attorney if you decide to go this route.
Also See: What Is a Vendor Take-Back Mortgage and How Does It Work?
Rent-to-own
Rent-to-own arrangements allow you to lease a home with either an option or requirement to purchase it after a few years. They share the same appeal as owner financing, along with similar drawbacks.
A major risk of rent-to-own arrangements is that if the property owner is unscrupulous or irresponsible, you can overpay for housing during the rental phase and never end up owning the home. Again, proceed with caution and speak to a real estate attorney if this option sounds enticing to you.
Home equity loan
If you already own a home and have a lot of equity, you may be able to use a home equity loan to purchase an inexpensive second home that you can’t get a small enough mortgage for. Your lender may even waive your closing costs.
Learn More: Private Mortgage Insurance (PMI): What It Is and How It Works
