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A full 90% of people buying a home as a primary residence choose to finance their purchase, meaning that they get a mortgage. Lenders like to see good income, low debt, strong credit, and of course, enough money for a down payment. That’s the amount of cash which will become your initial equity in the home. If you’re thinking about buying a home, you’ve no doubt started saving up for the down payment. Generally, mortgage lenders like to see a 20% down payment, but do you really need that much?
Do You Really Need a 20% Down Payment for a House?
There are some really good reasons to strive for a 20% down payment when you buy a home. If you are able to put this much down, you are not required by most lenders to pay private mortgage insurance (PMI - more below). Also, with a 20% down payment, you are likely to be offered lower interest rates on your mortgage. You get these perks because, with a substantial stake in the home, you are presumably less likely to default on your mortgage. After all, if you did so, you would lose a large chunk of money.
But, let’s get real. Saving up this much money in the current economic environment—where wages have been flat for years while rents and home prices have been rising—is extremely difficult. Even more so for first-time home buyers who are younger, earn less, and often have high levels of student loan debt.
Here in the real world, the median down payment for first-time home buyers is just 6%, according to 2014 data from the National Association of Realtors Profile of Home Buyers and Sellers. The median initial payment repeat buyers put down is 13%.For the current median priced home sale of $234,000, that looks like this:
Typical Down Payment for a Median-Priced Home Costing $234,000
First-Time Homebuyer @ 6%
Repeat Home Buyer @ 13%
How to Buy a House with Less than a 20% Down Payment
Don't have 20% to put down? Not to worry. Most would-be homebuyers who can’t come up with a huge down payment have many options when ready to purchase a home.
With a down payment of at least 5%, you can often qualify for a conventional mortgage loan, as long as you have adequate income, a reasonable debt-to-income ratio, and a credit score that exceeds the lender’s required minimum, typically between 660 and 700. You'll still be offered a decent interest rate for this type of mortgage, but you'll just have to pay what's known as private mortgage insurance (PMI). This insurance protects the lender (not you) in case you default, and in most cases you only need to pay it until you attain a loan to value ratio of 78%. It typically costs between 0.5% and 1.0% of the borrowed amount (that's about $100 a month for a median-price home purchase).
If you don’t have the 5% down payment, or you fall short on the other requirements, you can still qualify for a mortgage through a federally backed program. Different ones are offered through the Federal Housing Administration (FHA), Fannie Mae and Freddie Mac, the Department of Veterans Affairs and the USDA, for example.
Programs that Help You Buy a Home with A Small Down Payment
One commonly used option is the FHA program, which has backed as many as 37% of the mortgages issued in the U.S. in recent years. It insures mortgages for homebuyers with lower credit scores, higher debt-to-income ratios, or less money for a down payment. To qualify for an FHA-backed loan, you generally need 3.5% down. That would be $8,190 on the median-priced home of $234,000, although you may be able to use money gifted to you from friends or family members. Your credit score should be 580 or higher, and your debt-to-income ratio can creep up to 56% or so. If your numbers look a little different, for example, your credit score is below 580, it’s still worth looking into the possibility of getting an FHA-backed loan.
Another new option recently introduced by Fannie Mae allows a down payment of just 3% and says the income of non-borrowing household members, as well as rental income, can be used to determine the debt-to-income ratio. The program is called HomeReady, and will be available for home purchases in specific low-income census tracts and other designated areas.
The downside of these more forgiving mortgage programs is that they may hit you with a number of extra costs which can lead you to ultimately pay a lot more for the house than you would have with a conventional loan. With an FHA-backed loan, for example, your cost for mortgage insurance would be 1.75% upfront on the loan amount (it’s often added to the loan amount and financed), and an additional 0.85% of that amount annually for the life of the mortgage.
The table below shows the difference in how much you end up paying, assuming you have a 3.5% a down payment, and you bring the upfront mortgage insurance amount in cash at closing. If you financed it instead, the numbers would be even worse.
Cost of Mortgage Insurance with an FHA Loan for a Median-Priced Home
Upfront Mortgage Insurance
Annual Mortgage Insurance
Total Cost of Mortgage Insurance over a 30-year Mortgage
Due to the high ultimate cost of paying all that mortgage insurance, it makes sense to refinance the mortgage as soon as you can eliminate that requirement. Still, it's heartening to know that help is out there for families hoping to purchase a home, but falling far short of the 20% down payment.