Ups and Downs of Down Payments
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Conventional wisdom tells homebuyers to save up a 20% down payment for their homes. But this general rule isn’t widely observed. In 2017, the median down payment in the U.S. was 10% for all homebuyers and just 5% for first-time buyers, according to the National Association of Realtors.
Of course, there are good reasons 20% has become the benchmark number that homebuyers are encouraged to shoot for. It’s not a fast way to build equity. You’re more likely to score a lower mortgage rate and reduce the all-important debt-to-income ratio, which then makes you more likely to qualify for a mortgage in the first place. Furthermore, putting down at least 20% means you can avoid paying private mortgage insurance (PMI).
In spite of these pros for a larger down payment, it’s understandably tough for buyers to put down 20% upfront, especially if they are in an expensive market.
In fact, it’s not always better to make a large down payment, especially when there are many low down payment choices available to homebuyers today. When deciding how much to put down on a mortgage, you need to to make a holistic assessment of your own financial situation as well as familiarize yourself with your local housing market trends.
Deciding how much to put down on a mortgage
How do you decide how much to put down? Unfortunately, there is no generic answer that fits everyone.
In general, the bigger the down payment, the lower the amount of money you borrow, and the lower your mortgage payment is likely to be. This will save you money in two ways. One, you will pay less in mortgage interest over time. Two, it will lower your monthly payments for the life of the loan.
It’s common these days that many first-time homebuyers are also grappling with student loans and other types of debt. In a housing market where home prices are steadily increasing, experts say it may make more sense for most people to buy a house with a smaller down payment, which could free up funds to get rid of other debt that carrying a higher interest, instead of scrounging up for that 20% down payment.
Options for smaller down payments exist with good terms for eligible borrowers. In this post, we have mortgage experts analyze four down payment options and list the pros and cons of each.
|No down payment mortgage options|
|Pros of a 0% down payment||Cons of a 0% down payment|
Backed by the Department of Veterans Affairs, VA loans allow eligible veterans to purchase homes with a 0% down payment as long as they have “satisfactory credit.” While mortgage insurance is not required, first-time VA loan borrowers currently have to pay a funding fee of 1.25% -2.4% of your loan amount.
It’s important to note that the VA does not issue loans itself. Rather, conventional lenders are approved by the VA to issue loans on their behalf. That means you’ll have to meet the individual lenders borrowing requirements in order to qualify.
Americans may qualify for a USDA mortgage loan if they live in eligible rural areas. The program is designed to help low- to moderate-income homebuyers. Borrowers who meet the income and address eligibilities don’t have to put down anything to secure a loan. Although the USDA does not impose a minimum credit score requirement, lenders typically require a minimum credit score between 620 to 640 for a USDA loan. Through September 2018, USDA borrowers will have to pay an upfront guarantee fee of 1% at the closing of a loan and an annual fee of 0.35% of the loan amount.
|Putting down less than 5%|
|Pros of putting own less than 5%||Cons of putting own less than 5%|
Fannie Mae’s HomeReady mortgage program is designed for low-income homebuyers. The HomeReady loan requires a minimum 3% down payment, but borrowers have to pay mortgage insurance until your loan-to-value ratio falls to 80% or below. You don’t need excellent credit to qualify; you can secure a loan with a minimum FICO score of 620.
This is Freddie Mac’s answer to Fannie Mae’s HomeReady mortgage program. Similarly, Freddie Mac allows borrowers to put down 3%-5% for a Home Possible mortgage. Mortgage insurance is required, but it can be removed after your home equity reaches 20%. You don’t actually need a credit score to secure a loan if you make a 5% down payment. However, this loan is only available to only low- to moderate-income homebuyers or people in high-cost or underserved communities. Use this tool to determine if you can qualify for a Freddie Mac Home Possible mortgage based on your home address and income.
Borrowers can put down as little as 3.5% of a down payment for an FHA loan, insured by the Federal Housing Administration. But if you have a poor FICO credit score (500-579), the down payment requirement can go up to 10%. The downside is you’ll have to pay a one-time FHA mortgage insurance premium upfront and a monthly insurance premium, regardless of how much you put down. Still, if your credit is not great and you can’t put down 20%, an FHA loan is a good option for you. Check out the U.S. Department of Housing and Urban Development (HUD)’s searchable database to find FHA-approved lenders in your area.
Some mortgage lenders offer small down payment mortgages — as little as 3% down payment — to borrowers who qualify. For example, Bank of America offers an affordable loan solution that requires just 3% down and borrowers do not have to pay for private mortgage insurance either. Just keep in mind these types of loans will likely come with higher mortgage rates.
If the lender does require PMI, remember, you can request to have your PMI dropped once you have at least 20% equity in the home.
|Putting down 10%|
|Pros of a 10% down payment||Cons of a 10% down payment|
SoFi is an online lender offers mortgages up to $3 million with as little as 10% down payment. But borrowers typically need a stellar credit score — at least 680 — to secure a SoFi mortgage. The good thing is SoFi doesn’t require mortgage insurance nor does it charge origination fees. That being said, you are likely to have a higher mortgage rate than you might find at another lender that does charge PMI.
Putting down 20%
In general, a 20% down payment makes more sense for people who are debt-free and have a flush emergency fund already in place.
A 20% down payment will probably get you a better interest rate than what you’d get with a lower down payment. Sharga said if you have a low FICO score, you could offset some of the risks you present as a borrower with a down payment larger than 20% to get a better mortgage rate.
|Putting down 20%|
|Pros of a 20% down payment||Cons of a 20% down payment|
Dealing with PMI
You can typically request your lender to cancel PMI once you have reached at least a 78% loan-to-value ratio on your mortgage.
How to get help with your down payment
Donations from family and friends
Crouse said rules on receiving cash gifts to pay down a house have relaxed since 2016; It’s common with conventional financing that lenders don’t require personal funds as the sole source of funding for a down payment. Sharga suggested you check with your lender about donations as different lenders may have different policies.
FHA-secured loans allow borrowers to pay down a house with gifts from friends and family, although documents to explain ties with the borrower are required.
Fannie Mae’s HomeReady loans don’t require minimum personal funds for a down payment, either. It instead allows borrowers to use multiple sources of funding for their down payments, such as a gift from family or friends.
Down payment assistance programs
There are also third-party organizations — local governments, charitable foundations and others — that provide financial assistance for homebuyers to put together enough money for a down payment.
Oftentimes, down payment assistance programs impose income eligibility requirements and are limited to first-time buyers for their primary homes. Down payment assistance can come in forms of grants or forgivable loans. You may be asked to repay it when you sell the home, or it may be waived if you stay in the home long enough. For instance, this program in New York offers up to $25,000 to eligible first-time homebuyers
We recommend you reach out to your state and local Housing Finance Agency to learn about these assistance programs. You can also visit the Down Payment Resource website that tracks financial-assistance programs from over 1,200 Housing Finance Agencies.
How much to put down for a home is a personal decision, and you should assess your personal finance carefully before making the decision. However big a down payment you make, you should not deplete your savings for that. Because this may leave yourself exposed to significant financial risks when an unexpected emergency happens, such as losing a job. You want to make sure that you always have some cash reserves on hand.