As a first-time homebuyer, do you actually need a down payment? The simple answer is yes, if you plan to take out a loan (rather than pay in full with cash). We’ll talk about down payment amounts a little later, when we get into the different types of loans you may be using. A good key to remember is that the down payment plays a significant role in getting a lower interest rate on your loan, as well as being a desirable buyer to the seller and mortgage lenders.
When it comes to a down payment, one size does not fit all – whether we’re talking about your budget or the type of home you’ll be purchasing. The down payment can actually be as big or as small as you desire, as long as you can meet the required minimum amount for your lender.
Keep in mind, there are pros and cons to putting down a large amount as well as a smaller amount! That may sound confusing, so let’s jump right in, starting with the larger down payment – the standard 20%.
The 20% down payment option
The biggest pro of putting down 20% is pretty easy to explain. Simply put, the more you put down up front, the less you owe the lender, which means the less you’ll pay in payments every month. If you have enough money saved up to consider this option, then it may be the obvious way to go. However, not to worry if that isn’t you.
Let’s say you have been saving for a while and actually have almost 20% in the bank. Well done! But, if using it would completely wipe out your savings you may be putting yourself at risk. Everyone loves the idea of lower payments and saving that money on a monthly basis, but let’s take a look at the reality of owning your first home. Things can get messy.
Which brings us to a major con of using up all your reserves to meet a larger down payment commitment – putting yourself at risk if something should go wrong. Even if the house was perfect when you bought it, things happen. And unlike a rental, where your apartment manager or landlord is responsible, owning your own home means you own the problems too.
It could be a major event like losing a hot water heater or air conditioning unit – or as simple as a garage door motor that’s given up the ghost. Either way, there’s no one to call as backup when it’s your home so keeping a certain amount of savings in the bank could save you an emergency situation down the road.
MYTH: You must always provide a 20% down payment
One of the most common misconceptions homebuyers face today is that they are required to make a large down payment on their first home purchase. While there are still benefits to providing 20% down, most mortgage loans do not actually require that much. Still, many Americans, especially first time home buyers, are misled by the media, their parents or their mortgage lenders to believe that they need to save money to put 20% down on the purchase of a home. That thought couldn’t be more wrong.
The average down payment is around 8%
If that’s true (which it is!) that tells us that some home buyers provided down payments that were even less than 8%, according to a survey done by the National Association of REALTORS. Many buyers are unaware that there are several low-or-no down payment options that most buyers can easily take advantage of.
There are many benefits to making any type of down payment, period. Although not always necessary nor required, providing a down payment creates a lower loan balance. In return, the buyer gets to make smaller monthly payments and pays less interest over the life of the loan. With some conventional mortgage loans, providing a down payment of at least 20% will eliminate the need for the mortgage lender to require Private Mortgage Insurance (PMI). In addition, with a greater down payment, a buyer may receive a better mortgage rate.
There can be drawbacks to making a down payment
The most obvious drawback is simply not having the cash in the bank to make a down payment and having to wait longer (to save) to get financing for a mortgage loan. Even if you do have the needed cash in your savings, completely depleting your account is likely not a smart move in the event of an emergency or repairs needed for the house. Still, many choose to provide a down payment to help lower their mortgage rates. Which is a smart idea in theory, however, even with a large down payment there is no guarantee that a lender will grant you a better rate with more money down. A mortgage rate is determined by many factors and the amount of the down payment is only a small factor when determining the rate.
Less than 20% down payment options
An obvious pro of putting less down is the money you can save up front. Not only will it allow you to reach your goal of home ownership sooner, it will hopefully allow you to keep some reserves in the bank too. Which can offer peace of mind if anything happens with your new home, or personal circumstances.
The biggest con of a lower down payment is the upfront costs you’ll be required to pay as a result. There are fees associated with paying less, including primary mortgage insurance. A lower down payment also means you’ll be paying the lender more in the long run, with higher interest costs over the life of the loan. It may be a fair trade when you think about the opportunity to own your home sooner – and have a little extra money to enjoy living in it – but carefully weigh the options before making either decision.
MYTH: There are no options for low-or-no down payment
If you are working with a good mortgage lender he/she should be able to let you know what loan options and/or assistance programs are available in your area. Most financial institutions have applications readily available for down payment assistance programs or at the very least can provide a buyer with a local web address to complete the application. Buyers need to be prepared to speak up to mortgage lenders and have confidence that there are assistance programs available and should not be afraid to ask their lender what is available for use in the local area. Just like with any purchase, online search engines are a great resource to research financial aides in the state of purchase.
There are plenty of programs for less than 20% down payments!
We told you it’s possible to buy a home or condo without putting 20% down, the benefits and drawbacks of making a down payment and explained that there are assistance options available, and now it’s time to tell you what some of those options are.
0-3% down payment loans
First of all, you will likely need to qualify for loans that allow you to put 3% down or less. Whether it’s a certification course, military background or something else, do your research to make sure you fit the criteria needed.
If you have served in the military, you could qualify for a Veterans Administration (or VA) loan which means zero down payment is required. This type of loan is available to those in active duty as well as those who were honorably discharged. In addition, someone who has spent at least 6 years in the Reserves or National Guard are eligible, as well as spouses of those who were killed in the line of duty.
The downside to this type of loan is that it has to be used for primary residency which simply means you can’t get this type of loan for a second home or an investment property. There are fees associated with this loan as well, that go back to the VA to keep the program going. The good news is they can be factored into the price of the home rather than paid up front.
Another type of loan that doesn’t require a down payment is the USDA, United States Department of Agriculture, loan. This is a loan that assists people who have a low to moderate income. The loan allows the buyer to put down what they can afford, which in some cases may be zero.
One thing to keep in mind with this loan is that the property typically has to be located in a rural location to qualify. That doesn’t always mean a property in the middle of nowhere but it’s likely not in a metropolitan area and could be in a less than desirable subdivision. If you are willing to expand your horizons and explore new areas, this might be a good option for you.
This loan has many benefits, such as the zero down payment and ability to finance repairs and closing costs, but it also has limitations. Where you can buy a home is one of those restrictions but you’ll also be looking at income restrictions and if you’re over the limit, this loan isn’t for you.
Down payment assistance programs
Let’s take a moment to pause and talk about down payment assistance options. There are programs that exist to assist with the closing costs as well as down payments. If you qualify, you may want to look into them in addition to any loan options you may be considering.
Typically, the actual amount of the assistance will be determined by your income, and the best benefits apply to those who qualify as low to moderate income households. The income restrictions will be different by area, so take the time to look at the County programs that exist where you plan to buy your home. If you’re not sure where to start, ask your real estate agent or mortgage lender. As the experts in this area, they will likely have helpful information as you begin your research.
These types of assistance most often require you to complete a pre-purchase home buyers education program and have at least one-month mortgage payment in savings. You do have to be a first time home buyer to qualify for this assistance, but that doesn’t necessarily mean you have never owned a house before. The good news is if you have been renting and haven’t owned a home in three years, you can now be considered a first time home buyer again and apply for these programs.
3.5% down payment loans
Putting 3.5% down is slightly more common, but also comes with certain criteria you must meet. Read your options below.
FHA, or Federal Housing Administration, loans have a small reserve requirement, starting at 3.5%. These loans are also great if your credit is less than stellar. Outside of the VA and USDA loan options, the FHA loan has the lowest down payment requirement anywhere!
FHA loans offer a little more flexibility when it comes to where you get your down payment too, which means you can use money that’s a gift if it comes from a blood relative (or someone that you have a family like relationship with). As long as they don’t expect you to repay them (and are willing to sign a paper that says so) you should be good to go!
A lender wants to know that if something were to happen, you would have enough money in savings to take care of the emergency – and still make your monthly mortgage payment. This savings requirement can be pretty high with other lenders, but with an FHA loan, the standard is only one month of expenses.
If you’re thinking this all sounds great, it may be time to talk about the downsides of an FHA loan. The biggest con with an FHA loan, and putting down less than 20%, is the requirement the lender will have for primary mortgage insurance. This is a cost that you will pay monthly to ensure the lender is covered in the event you can no longer make payments. Consider the amount you’ll be adding to your monthly payment as you balance the benefit of putting less down up front.
If you were planning on purchasing a “fixer upper” for a low price, an FHA loan may not be for you. Your new home has to meet certain standards and have everything in working order for the loan of this type of be approved.
And last but not least, if your first house is going to be on the expensive side, you may not qualify for an FHA loan. Outside of certain areas of the country known for high costs (think NYC or Los Angeles), the cap for FHA loans run around $300,000.
Fannie Mae Home Ready Loans
The Fannie Mae Home Ready Loan is similar to FHA loans and caters to low to moderate income families. It also works with applicants who have low credit, although the minimums are higher than FHA so you’ll have to qualify to be able to use this loan.
One of the big differences with the Fannie Mae loan is that the primary mortgage insurance requirement drops off, meaning you could see your payment decrease earlier than you might with an FHA option.
This loan allows your down payment and closing costs to come from a variety of sources, including gifts and grants. This is great news is your personal savings are on the low side, but you can qualify for a grant – or have some generous friends and family!
Things to consider about your down payment
If you qualify for a loan option above, or even a conventional loan that allows you to put less than 20% down, don’t automatically put less if you can afford more. Here’s why – just because you can put less down technically, doesn’t mean that you will get the best rates or that you’ll be saving money in the long run. Work with your team of experts to compare things like upfront closing costs, with the cost of PMI and the interest rates you’re being offered.
For example, if you’re able to put more down up front, you may be able to reach 20% equity more quickly (meaning you’ve paid off 20% of your home’s value) and reduce your PMI costs. Of course, at the same time, if you do qualify for an option above and you don’t have the extra savings, that’s ok too. These options are designed to help you get into a house earlier so weigh the costs with the benefits of getting into your first home.
And remember, these options are designed to put you in the driver’s seat. You don’t have to try to “time” the housing market or play any games. Instead, we’ll help you get educated on the options, the costs and the best ways to start saving and make your dream a reality.