Is 20% Down Really Necessary to Buy a Home?
Is 20% Down Really Necessary to Buy a Home?
No, putting down 20% isn’t necessary to buy a home, but there are many advantages to making a down payment of at least 20% before purchasing a house. If you can’t afford a large down payment, there are other options.
Benefits of Putting Down 20%
Putting down 20% saves you money in the long run, as you can avoid paying for the additional cost of mortgage insurance. More importantly, you can qualify for the lower mortgage interest, which saves you a lot of cash over the long term. A large down payment reduces risk for lenders, which means they can offer you better terms.
However, there isn’t any actual requirement that you put 20 percent or more down unless you have bad credit or are taking out a very large loan. Even if you don’t have very good credit, there are still options that allow you to put down as little as 3% of the purchase value of a home.
Benefits of a Small Down Payment
A smaller down payment gives many buyers the option of purchasing a home quicker than they otherwise would be able to. A 20% down payment on a $500,000 home would require a $100,000 down payment, which is unreasonable for the vast majority of American families. Compare that to a 5% down payment of $25,000, which is a much more realistic goal for a middle-class buyer.
A small down payment means you will have to pay for mortgage insurance, which usually requres a payment of 0.5%-1.0% of your monthly payments. While this additional cost adds up over time, so does the cost of renting a home for years and years on end. At the end of the day, this is a small cost to bear, as opposed to waiting a decade or more to purchase a home with 20% down.
Downsides of a Small Down Payment
A small down payment is a risk for your mortgage lender, so lenders prefer big down payments, as it makes the loan much safer. Paying a small down payment makes sense if that is all you can afford, but try to budget for a substantial down payment if you can. A small down payment will increase your costs over time, with mortgage insurance and higher interest rates. Additionally, your monthly mortgage payment will be higher, and it will take longer for you to pay off your loan.
How to Secure a Mortgage With a Small Down Payment
There are several options for buyers who can only afford a small down payment.
FHA home loan
The FHA loan is a common avenue for buyers looking for a low down payment. FHA mortgages require only 3.5 percent down, and most mortgage lenders offer this option. You can qualify for these loans at reasonable interest rates, even if your credit isn’t ideal. If you put down less than 10%, you will have to pay mortgage insurance and additional fees, but this is a good option for buyers who need time to build their savings and credit.
Fannie Mae/Freddie Mac
Fannie Mae and Freddie mac offer backed loans, otherwise known as conventional loans. Fannie and Freddie do not directly offer loans, but instead guarantee loans that meet their criteria. Many lenders offer mortgages backed by Fannie or Freddie for as little as 3 percent down, although down payments of a minimum 5-10 percent are more common. Fannie and Freddie loans require better credit than FHA loans, but typically offer better terms.
Veterans Administration (VA) loans are a great option for those who meet the eligibility requirements. Using VA loans, veterans and their families can buy their first home with no money down in many cases, and can sometimes skip out on down payments for future purchases too. Despite the low down payments, interest rates and other terms are typically quite friendly. Because of this, VA loans are the preferred method for people who qualify.
USDA Rural Development Loans
USDA rural development loans offer zero percent down for eligible buyers. Eligibility is income-based. Additionally, homes purchased through the loan have to be modestly priced, and borrowers need to currently not live in inadequate housing. People living in rural areas, but also small towns and far-out suburbs, can qualify for this loan. However, funds are limited, so there is typically a large waiting list for the USDA loans.
State and Local Housing Agencies
Many state and local housing agencies offer programs that assist with down payments in the form of grants, loans, and other monetary assistance.