For those of us with big dreams of buying a home, there may come a time when the dream becomes reality. To make homeownership a reality, you’ll need to meet its challenges. There are financial hurdles you’ll need to clear before you can grab those house keys. One example of that would be making a down payment on a house.
You’ve likely heard that your down payment should be 20%. More, sometimes, but definitely never less, right?
Well, not quite.
Historically, down payments have been 20%. But today, the world of real estate is far different than it was when our parents were aspiring first-time homeowners.
Different kinds of mortgage loans have different requirements – and some loans don’t require big down payments at all. Some lenders only require 3% – 5% down. Now, don’t those numbers look a whole lot less terrifying?
Rather than freaking out over a big down payment, do a little research into your available options and payment assistance programs. You might even come to realize that you’re in a much better position to purchase a home than you thought you were.
Do I HAVE To Pay 20% Down?
There are lots of things you have to do in life – like brushing your teeth, eating, or paying taxes – but putting 20% down on a house isn’t one of them.
In the days before the internet, a 20% down payment was pretty standard. If you wanted to buy a house, you had to have 20% to put down – or no mortgage for you! Today, that’s changed.
Today’s homebuyers can expect far better deals than previous generations. Many home buyers can even end up paying 5% or less.
Let’s take a look at how the size of your down payment can impact the cost of your loan.
The importance of down payments: Seeing them in action
Down payments are important because they play a major role in determining your monthly mortgage payments.
The cash you “put down” pays off a portion of the home’s sale price. The more you put down for the down payment, the less you have to borrow from a lender. So, making the largest down payment you can afford could be a wise investment.
Let’s say you buy a $200,000 house and put down $40,000 (the full 20% down payment), you’ll only have to borrow (and pay interest on) $160,000.
Now, same hypothetical house, different down payment scenario. If you put 0% down, you would have to take out a loan for $200,000. And that means paying interest on $200,000 (instead of $160,000). Because some lenders charge private mortgage insurance (PMI) on mortgages with lower down payments, the premium could also hike up your monthly mortgage payment.
Use a home affordability calculator to explore different financial scenarios. Who knows, you may be pleasantly surprised!
What Is the Minimum Down Payment Required on a House These Days?
Much like jeans, no lender is one-size-fits-all.
There are all kinds of lenders willing to offer all kinds of mortgages and there are all kinds of government programs to try on when a traditional mortgage isn’t the right fit. Rather than assuming a loan isn’t right for you, throw it back to your school days and reconnect with your research skills.
Here’s what you can expect to find while researching available lending opportunities:
- Federal Housing Administration (FHA) loans: These are government-backed loans that are insured by the FHA. Down payments on FHA loans can be as low as 3.5% (a far cry from 20%). FHA first-time home buyer loans are a popular option for this very reason. Applicants need a FICO® score (aka credit score) of at least 580 to qualify for a 3.5% down payment. A credit score between 500 and 579 requires a 10% down payment, depending on the lender. Plus, your debt-to-income (DTI) ratio (how much debt you have compared to your income) must be under 43%.
- Department of Veterans Affairs (VA) loans: These loans are available to active-duty service members, veterans or surviving spouses. VA-backed home purchase loans don’t require down payments, offer low interest rates and can be used in amounts up to the Fannie Mae/Freddie Mac conforming loan limit, which is $548,250. Plus, private mortgage insurance (PMI) isn’t required.
- U.S. Department of Agriculture (USDA) loans: USDA loans can be a perfect fit for home buyers looking to purchase in rural areas with small population sizes. Availability and loan borrowing terms can vary from state to state, and borrowers must meet USDA loan income limits. USDA loans usually don’t require down payments, and interest rates are locked at low levels.
- Conventional mortgages (like Fannie Mae HomeReady® and Freddie Mac Home Possible®): When most people talk about mortgages, they are often talking about conventional mortgages. Because lenders have their specific requirements, there are no universal truths that can be applied to conventional mortgages. Down payment requirements can be higher with a conventional mortgage, but most don’t require 20% – especially for borrowers with high credit scores and a solid credit history. Some conventional mortgage lenders even offer down payment options as low as 3%. Conventional lenders may require PMI if the borrower can’t make a 20% down payment, but this isn’t always the case.
THE Best Bet: What Is the Average Down Payment on a House?
If you’re still worried about having to make a 20% down payment on a house, don’t be. We’ve got another relevant number to share with you. According to the National Association of REALTORS®, in July 2021, 72% of home buyers put down less than 20% on their homes.
Whew, right? Buuut … there is a difference between the average down payment and the right down payment for you.
No matter what you’ve got tucked away in your savings account, how much you make or what kind of house you have in mind, the best down payment for you is the one that allows you to stay within your budget and doesn’t force you to make drastic lifestyle changes to afford the house.
Check out your loan-to-value (LTV) ratio
LTV is a popular metric with lenders. If you’re not familiar with it, now’s the time to get acquainted. LTV compares the amount of a loan to the value of the property you want to buy with the loan. So, before you move ahead with a mortgage, it would be a good idea to pull out a calculator and get to number crunching.
Say you have your eye on a $200,000 home and plan to put down 6% (or $12,000). You’ll have a mortgage balance of $188,000. To calculate LTV, divide the mortgage balance by the home value and multiply it by 100. In this case, the LTV is 94% (which is typically considered high).
Lenders use LTV to determine lending terms. A low LTV means a buyer has more equity in the home. In general, the lower the LTV, the better loan terms a borrower can expect to get. And that usually means you’ll get a lower interest rate.
LTV can affect PMI, too. Private mortgage insurance is an extra form of protection for buyers who won’t have significant equity in a home at the time of purchase (hint: buyers who make a low down payment). If you reduce your LTV or start out with an LTV of 78% or lower, you won’t have to pay PMI.
The bottom line? The higher the down payment, the lower your monthly mortgage payment will be. If you can afford it, that’s a great situation to be in. But you shouldn’t break the bank and jeopardize your budget to meet the 20% mark.
Going All In: Putting Down Your Down Payment
The moral of the story is that you can get a home loan without having to clear the 20% down payment hurdle.
Educate yourself on available options and be realistic about what you can afford. The more you know, the closer you’ll get to owning a home.
Federal Housing Finance Agency. “FHFA Announces Conforming Loan Limits for 2021.” Retrieved September 2021 from https://www.fhfa.gov/Media/PublicAffairs/Pages/FHFA-Announces-Conforming-Loan-Limits-for-2021.aspx
National Association of REALTORS®. “REALTORS® Confidence Index.” Retrieved September 2021 from https://cdn.nar.realtor/sites/default/files/documents/2021-07-realtors-confidence-index-08-23-2021.pdf