Whenever you hear people talk about buying a home, they insist you need a 20% down payment. But there are ways around that. We will show you how to buy a house without putting 20% down.
There are some good reasons to put 20% down when you buy a house. But that isn’t realistic for everyone, and it’s not only rich people who deserve to own a home. If you are dreaming of buying a house but can’t come up with 20% down, there are programs that can help.
Getting on the Ladder
Millenials are not buying homes at the age or rate their parents did. And it’s no mystery why.
Even though the labor market has shown some signs of improvement, the financial situation for millennials remains pretty grim. Americans owed $1.3 trillion in student loans by the end of 2016, and millennials alone give over roughly a fifth of their salaries to loan payments, according to Citizens Bank. That’s thousands of dollars each year that cannot go toward a down payment on a home.
A fifth of your salary is 20%, and 20% is what we are always told we need for a down payment.
Why do you need a 20% down payment and do you really? Some lenders are reluctant to make loans to people who don’t have a 20% down payment. They got burned when the housing bubble burst in 2008 when they were handing out mortgages like opioid prescriptions to people who couldn’t afford 10% down nevermind 20%, and they don’t want to get burned again.
A bigger down payment means a smaller monthly payment and paying less interest over the life of the loan so putting 20% down saves you money in the long run.
And in the short run too because if you don’t have at least a 20% down payment, you will have to pay PMI. PMI is private mortgage insurance. It’s additional insurance that lenders require homeowners to pay when they have less than 20% to put down.
PMI typically costs from 0.5%-1% of the entire mortgage amount on a yearly basis. All of the numbers we use in this episode are based on a $150,000 home (you can’t double the numbers for a $300,000 home because some numbers are a percentage). So for our home, PMI would be $750-$1,500.
You can ask your lender to remove PMI when the mortgage has been paid down to 80% of your home’s original appraisal value and when the mortgage balance is down to 78%, the lender is required to remove PMI.
The Efficiency of Your Dollar
So you can see that it makes the most financial sense to put down 20% to buy a house. That is the most efficient use of your dollars. What did you eat for dinner last night? Was it rice and beans and water? If it was anything else, you did not spend your food dollars as efficiently as you could.
Humans are not always entirely efficient or even often efficient. Sometimes we want a steak and a glass of wine for dinner instead of rice and beans and water.
And some people want to buy a house for a variety of reasons, they want to practice the drums without disturbing the neighbors, they want to buy a duplex and rent out the other half to generate passive income, they want a backyard for the children or pets to play in, and for another variety of reasons, they can’t come up with 20% down.
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You Don’t Have to Have 20%
While it is ideal to have a 20% down payment to buy a home, there are programs available that can get you into a home without it. That said, if you are a military borrower, you can use the VA Loan Guaranty Program rather than the programs we are discussing today.
FHA Mortgage Loan
FHA stands for the Federal Housing Administration which is a government agency. An FHA mortgage loan is a program intended to increase homeownership for low and moderate-income Americans. You can use the loan calculator here.
-The down payment requirement is just 3.5%, $5,250 for our example.
-If a borrower is struggling to come up with the down payment, these loans can be paired with down payment assistance programs.
-Gifted money can be used towards the down payment and closing costs.
-Borrowers only need a credit score of 580. Even those who have had a foreclosure or filed bankruptcy recently can qualify.
-There are no minimum or maximum income limits, but buyers will need to show they have a steady income and a steady history of employment.
-These loans offer a low-interest rate which means a lower monthly payment and a less expensive loan over time.
-Buyers can purchase a duplex with this loan making it possible to generate passive income by living on one side and renting out the other.
-An FHA approved lender must be used.
-There are limits on how much you can borrow and vary based on the location you are buying in.
-PMI is required and for the entire length of the loan and must be paid up front.
-No fixer-uppers. A home has to meet specific standards to be considered for this loan.
Conventional 97 Program
To increase the number of mortgages offered in the US, Fannie Mae and Freddie Mac wanted a loan program to compete with the FHA loans program and the Conventional 97 Program was created.
-97 comes from the required down payment, just 3%, making the down payment just $4,500.
-Gifted money can be used towards the down payment, but it must come from blood or by-marriage relatives and must be given with no expectation of repayment.
-The minimum credit score is 620.
-There are no income limits.
-No upfront PMI required.
-PMI is removed after meeting the requirement mentioned previously.
-As the program is meant for first-time buyers, you cannot have owned a home in the past three years.
-The maximum that can be borrowed is $453,100.
-PMI is required. It will be rolled into your monthly mortgage payment.
-The home must be single family and the buyer’s primary residence.
-This is the most expensive loan option on the list, and we don’t recommend it.
Conventional Loan at 90% Loan-to-Value
Loan-to-value means borrowing a percentage of what the home is worth.
-The down payment is just 10% making it $15,000.
-The monthly payment would be $775.
-PMI is required.
-PMI will be almost 10% of the cost of the loan making this option expensive relative to the loan.
80/10/10 Piggyback Mortgage
This is a loan option that sees the buyer take out a first and second mortgage at the same time to cover 90% of the mortgage.
-The minimum credit score is 680.
-Whoo! A sneaky way to avoid PMI.
-You can pay off the second mortgage quickly and save on interest.
-You can deduct the interest from both loans on your taxes.
-You pay closing costs on both loans.
-The second loan rate is often variable which is a risk if interest rates rise.
-If you want to save interest by refinancing, you may have to pay off the second mortgage first.
HomeReady loans are offered by Fannie Mae to help low and moderate-income Americans buy homes.
-The down payment required is 3%, a down payment of $4,500.
-The program can be combined with down payment grant or closing cost assistance programs.
-Gifted money can be used towards the down payment and closing costs.
-Borrowers only need a credit score of 620.
-Non-traditional sources of income will count as part of your income.
-PMI can be removed after meeting the requirement.
-The loan can be used to buy a 2-4 unit property as long as the buyer lives in one unit.
-There are income limits by state.
-The loan amount limits range from $453,100 to $679,650.
-Borrowers have to pay PMI.
-The interest rates for this program are usually .125%-.500% higher than the rates on the FHA mortgage and other conventional mortgage programs.
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But Wait, There’s More!
These programs have lower down payment requirements than you will find when you get a conventional mortgage but they don’t offer help to meet the requirement. But there are down payment assistance programs available, and up to 87% of home buyers qualify.
The programs vary by state, and you can find out what you might be eligible for here.
Before You Get Too Excited
If you’ve been wanting to buy a house but thought it was out of reach because you don’t have a 20% down payment, you were probably looking for houses on Zillow before the episode even ended. Not so fast.
Fix Your Score
Credit scores are important, but when you start thinking about buying a home, they become critical. The higher your credit score, the less it costs you to borrow money. While you don’t need the almost mythical 850 to get the best interest rate, 760 is something to aim for.
It’s Not Just the Mortgage
A lot of people plug their numbers into a mortgage calculator, and their mouth starts to water. They could get a whole house for just a little more than they are “throwing away” on rent every month! But there are a lot of other costs involved when you buy a house including property taxes, possibly HOA fees, and all of the maintenance costs.
Before you get carried away, understand the hidden costs that homeowners are responsible for. Not to mention the fact that if something goes wrong, you can’t fix it by picking up the phone and calling the landlord. Whatever goes wrong is your problem and your expense.
Pros and Cons
None of these programs are straight up bad options for people who want to buy a house. They all have pros and cons and requirements so before you choose one, make sure you understand them all. You can go back to browsing Zillow now.