The impending arrival of a new baby is the moment when a lot of couples realize that their modest apartment won’t cut it anymore. Often, the only thing holding them back from buying a home is the lack of a substantial down payment.
It shouldn’t. For many younger renters, the perception doesn’t match the reality when it comes to home-buying requirements. According to a 2017 survey by NeighborWorks America, the average Millennial thinks the down payment for a house is 21 percent of the sale price. In reality, there are several programs that allow you to get a mortgage with a lot less than that.
Below is a brief look at some of the more popular options for buyers without a lot of cash on hand.
The Federal Housing Administration, or FHA, home loan program is one of the oldest and most widely used low-down-payment options on the market. Though the loans themselves come from private lenders, the FHA insures the banks and mortgage companies against default. To cover the cost, the federal agency charges consumers an upfront insurance premium – currently 1.75 percent of the loan amount – plus a monthly premium.
For a long time, FHA mortgages were seen as the place low-income buyers could go when they were denied a conventional loan. That changed after the Great Recession, when tighter lending guidelines meant more borrowers – even some in higher income brackets – couldn’t get financing anywhere else. Use of the program peaked in 2011, when a quarter of all U.S. mortgages were issued through FHA.
The program remains a compelling option for a lot of homebuyers. One of the biggest draws is the low 3.5 percent down payment requirement that makes ownership a possibility even for younger couples, who don’t have several years’ worth of savings to throw down on a property.
The program also offers interest rates that are roughly 25 basis points – or 0.25 percentage points – lower than those on conventional loans. What’s more, FHA mortgages are “assumable,” which means that when you sell your home, the new buyer can essentially take over your loan for you. If mortgage rates have risen since you took out the loan, that can feature can look awfully attractive to potential buyers.
The biggest perk of all may be the FHA’s low credit score requirement. Borrowers can get a loan with FICO scores as low as 500, far below that of most other programs (though you’ll need to put down 10% if your score is under 580).
Within the past few years, Freddie Mac and Fannie Mae – the entities that own or guarantee most of the mortgages in the U.S. – have given FHA some competition. Both now offer conventional loans with a minimum down payment of just 3%, edging out even the FHA’s relaxed guidelines. Borrowers who put down less than 20 percent have to pay private mortgage insurance, which protects the lender in the same way that FHA coverage does.
A lower down payment isn’t the only area where conventional loans have a leg up, though. For one thing, there’s no upfront insurance premium tacked onto your sale price. And you can ask to have your monthly premium canceled once your loan-to-value ratio falls to 80 percent (it’s automatically shut down when your LTV hits 78 percent).
That’s not the case with many FHA loans. If your LTV is above 90 percent, you don’t have the option to cut off your monthly insurance payment, no matter how much equity you have. In theory, you can refinance into another loan to shed that expense, but you’ll find yourself paying closing costs to do so. Nor is there any guarantee that interest rates will be as favorable a few years down the road as they are now.
That’s not to say that conventional loans don’t have their own drawbacks, especially if you’re FICO score isn’t exactly stellar. Under Fannie and Freddie regulations, you need a score of at least 620 to qualify. And because their monthly insurance premiums correlate to your credit ranking, those on the lower end of the spectrum pay more each month in PMI.
In addition, Fannie Mae’s standard program is only available to first-time homebuyers. It offers a separate option that’s open to repeat buyers called HomeReady, though it’s restricted to lower-income applicants.
While FHA and conventional, PMI-backed loans are appealing options for cash-strapped buyers, some borrowers may be eligible for mortgages with no down payment at all. The Veterans Affairs, or VA, loan program is one such option, although you have to be a veteran or active member of the military to take advantage (spouses of a service member who died or was disabled while on duty also qualify).
There’s no minimum credit score required to obtain a VA loan, and you don’t have to pay mortgage insurance on the loans, which are backed by the Department of Veterans Affairs. Instead, borrowers pay a one-time funding fee. You’d pay 2.15 percent of the mortgage amount if your loan covers 100% of the sale, although the fee is lower when you make a down payment.
Like VA loans, those offered by the United States Department of Agriculture also forgo the down payment requirement. Because the program is billed as a way to help families in rural areas, it’s easy to dismiss these loans out of hand. But the reality is, a lot of suburbs fall within the geographical boundaries established by the USDA. In fact, well over 90 percent of the land in the U.S. is eligible (you can do an easy address search here to find out).
As if the zero-down policy wasn’t enough, USDA mortgages also offer attractive interest rates and lower insurance premiums than FHA and conventional loans. You don’t need particularly high credit score to qualify, either – a FICO north of 580 is typically all you need.
But here’s the rub: You do have to meet the program’s goal of serving “low- to moderate-income households.” In practical terms, that means your family can’t bring in more than 115% of the median income in your region. For those who fall within those somewhat narrow guidelines, it’s a tough one to beat.
The truth is, though, that there are a lot of worthwhile choices if a 20% down payment just isn’t in the cards. It certainly doesn’t hurt to speak with multiple lenders and get their input on which program best meets your needs. But don’t just take their word for it, either. Analyze the Loan Estimates that they provide you, which should show not only the interest rate, but the closing costs and ongoing insurance premiums you’ll need to pay.