One of the biggest hurdles for first-time home buyers is saving up for a down payment. Cutting back on expenses and sticking to a budget can seem like a full-time job. With today’s home prices around the country, saving up for a 20 percent down payment—historically the standard down payment for a home—can be a virtual impossibility.
But don’t worry!
Several available loan programs and different financial products offer many accessible ways to purchase a home. Here are some of the best ways to buy a home with a down payment of less than 20 percent.
The Ins and Outs of Private Mortgage Insurance (PMI)
Home buyers looking to purchase a home with less than 20 percent down are in luck! Conventional mortgage lenders will extend home loans to qualified borrowers who are putting less than 20 percent down, but these borrowers must pay for private mortgage insurance (PMI) to cover their loan.
PMI is insurance that protects the lender if a borrower defaults on their loan, and PMI payments are typically rolled into regular mortgage payments.
A borrower’s ability to use PMI as a viable alternative for a 20 percent down payment will depend on the loan-to-value (LTV) ratio and the borrower’s credit score. The LTV ratio is the loan amount versus the down payment, and a higher LTV will mean higher PMI fees. Conversely, LTV ratios are lowered by increasing the down payment and, thus, decreasing the loan amount.
The borrower’s credit score plays the most significant role in determining PMI cost because it provides information on the likelihood that they will pay off the entirety of the loan; improving credit scores can save home buyers thousands of dollars over the life of the loan.
For example, suppose a borrower’s FICO score is above 700. In that case, the added cost of PMI can be virtually negligible, making PMI the most broadly accessible route to buying a home with a smaller down payment. It’s important to note that the cost of PMI increases as the down payment decreases, so the more a borrower can put down, the more affordable PMI becomes.
Government-backed mortgages are loans insured by agencies of the federal government. These mortgages offer the advantage of requiring down payments of 3.5 percent or less, making them far more accessible than conventional loans.
However, it’s important to note that borrowers seeking loans to be used in real estate investment won’t qualify for government-backed mortgages; they are intended for home buyers who will use the home as their primary residence. The Federal Housing Administration (FHA), the US Department of Agriculture (USDA), and the Department of Veterans Affairs (VA) are the three government agencies that insure loans for homebuyers.
Still, the majority of government-backed loans are through the FHA.
Home Buyers: Enlist Uncle Sam’s Help
Borrowers with a FICO score above 580 can qualify for an FHA loan with a down payment of just 3.5 percent. But potential borrowers with average or below-average credit can qualify, too. For example, home buyers with a FICO score between 500–579 can secure an FHA loan with a 10 percent down payment. As a result, FHA loans may be the best option for home buyers with average credit who want to put less than 20 percent down on a home.
With USDA- and VA-backed mortgages, home buyers can secure loans with zero-down financing. USDA loans are extended to home buyers in rural areas and require no down payment. VA-backed home loans, extended to military veterans, also require zero down payment.
It’s important to note that up-front closing fees come into play with zero-down financing. Closing fees apply whenever loan agreements are entered into; they usually total 2–5 percent of the loan amount. With conventional loans, the closing fees can be paid up-front or folded into the loan and paid off over the life of the loan.
This provides flexibility in out-of-pocket closing costs. But since government-backed loans take on more risk by giving favorable terms, they require up-front payment of these fees. For example, FHA loans require an up-front payment of 1.75 percent of the loan amount; USDA loans require a guarantee fee of 1 percent, and VA loans come with an up-front cost of 1.25–3.3 percent of the loan amount.
20 Percent Down: A Thing of the Past?
While home buyers no longer need to make a down payment of 20 percent to buy a home, it’s important to note that putting money down can provide a lot of savings. However, for prospective home buyers who have trouble saving for a substantial down payment, there are great and widely accessible routes to home ownership today.
For buyers with good credit scores, supplementing a loan with private mortgage insurance can enable the purchase of a home with a smaller down payment. In addition, government-backed loans are great for qualifying home buyers who want to make little or no down payment.
Thanks to these options, it’s never been easier to purchase a home with a down payment of less than 20 percent than it is today!