Zillow down payment loans can be forgiven, but not refinanced 

Zillow Home Loans, the mortgage arm of the home search giant, announced last week that it has launched a new product that provides down payment assistance to buyers who finance their home using an FHA loan.

"Buyers tell us the down payment is what's holding them back, and we hear the same thing from agents about their clients," Zillow SVP and General Manager of Mortgages Eric Wilson said in a statement. "This program helps us serve more qualified buyers by giving them a simple way to clear that hurdle, with their mortgage and down payment assistance handled in one place."

A second loan, no additional interest: The new product, which is available to qualified FHA borrowers across 43 states and in Washington, D.C., will serve as a second loan, Zillow said. It will not carry any additional interest or require extra monthly payments on top of the buyer's mortgage payments.

The loan will cover up to 3.5% of the home's purchase price, which is the minimum down payment required for an FHA loan. It does not have any income cap or first-time buyer requirement. The sweetest part of the deal may be that after five years of on-time payments on the primary mortgage loan and continuous owner occupancy, the down payment loan will be forgiven. 

How buyers can participate: Buyers will have the option of adding their own savings to the down payment from Zillow — up to 6.5%, for a total down payment of 10%. 

Other requirements for program participation include securing an FHA loan with Zillow Home Loans, purchasing a primary residence, qualifying for the full monthly mortgage payment under standard underwriting and having a credit score of at least 640. The primary FHA mortgage loan will include a standard interest rate and monthly payment.

Considerations to think twice about: Complete forgiveness of the down payment loan after five years of on-time mortgage payments and owner occupancy may sound like a steal to some. The catch is, if the buyer moves out, sells the property or refinances their mortgage before those five years are up, they will be required to repay the down payment loan in full, Zillow said.

The program is not currently available in Arizona, Delaware, Florida, Massachusetts, New York, Rhode Island or Virginia.

'Free money is never free': Ryan Stanek, a licensed mortgage loan originator with Edge Home Finance, said the product's five-year term is something that should be flagged for FHA borrowers who are considering the option.

"Plenty of buyers taking today's rates are counting on a refinance if rates come down," Stanek wrote in a LinkedIn post. "With this program, a refi in year two means paying back the down payment money as well."

Dee Bares, a mortgage loan originator at Paramount Residential Mortgage Group, also cautioned in a LinkedIn post that "free money is never free" and said buyers should still shop around, despite the lure of down payment loan forgiveness after five years.

"Make sure you understand what you're agreeing to," Bares wrote.