If you’re in the market to buy a new home or condo, you’ve undoubtedly thought (or stressed) about the down payment. But how much should you put down? Better yet, how much do you need to put down?
Well, back before the mortgage crisis unfolded, it was quite common for homeowners to come up with 20 percent of the sales price for down payment.
So prospective homeowners took their time, saved up money in the bank, and when the time was right, made a bid on a property.
The way the banks saw it, borrowers had “skin in the game,” and were therefore a pretty safe bet when it came to making timely mortgage payments.
Even if they did fall behind, those down payments would ensure the bank wouldn’t be stuck holding a property that was worth less than the mortgage. And there would be enough of a buffer to offload it without much if any loss.
Then Things Got Risky
But before long, mortgage lenders got more and more aggressive, allowing homeowners to come in with little or nothing down. Even closing costs could be piled on top of the loan, so you could get a mortgage with no out-of-pocket expenses.
This was all done on the basis that home prices would appreciate up and up, forever and ever.
Of course, we all know how that turned out, and so many of these types of loan programs are no longer available.
Sure, there are still some programs kicking around that allow you to come in with nothing down, but there are eligibility requirements and income restrictions.
The most widely used zero down mortgage program currently available is offered by the USDA. It’s a low-income, rural home loan program, meaning it’s only available to those who live outside major metropolitan areas.
There are also zero down VA loans available to veterans, but once again, this is only an option for a fraction of the population.
Most Borrowers Now Required to Provide a Down Payment
Nowadays, for the vast majority of borrowers, a down payment will be required, though not necessarily a large one.
If you’re looking to put very little down, the next closest thing to zero down is a Fannie Mae Homepath mortgage.
The program allows borrowers to come in with as little as 3% down when purchasing a Fannie-Mae owned property, otherwise known as a foreclosed property.
And the down payment can be a gift, grant, or a loan from a non-profit organization or an employer. The beauty of this program is that despite there being such a small down payment requirement, no mortgage insurance is required. But again, this program is only available on a small portion of the homes out there.
Update: Fannie Mae and Freddie Mac are allowing loans as high as 97% LTV again for those looking to put down just three percent. You can obtain these loans via Wells Fargo yourFirst Mortgage and Bank of America’s Affordable Loan Solution.
Mortgage Insurance Required
For most other loan programs, mortgage insurance will be required by the lender if your loan-to-value ratio (LTV) exceeds 80%. In other words, if you put down less than 20%, you’ll be stuck paying insurance to compensate for the increased risk. This is on top of homeowners insurance, so don’t get the two confused. You pay both!
Obviously this will increase your monthly housing expense, making it less attractive than coming up with a 20% down payment.
If you opt for an FHA loan, which allows down payments as low as 3.5%, you’ll be stuck paying an upfront mortgage insurance premium and an annual insurance premium.
And if you take out a conventional home loan with less than 20% down, you’ll also be required to pay private mortgage insurance. This is less than ideal if you’re trying to keep your costs down, but a decent option for those with little in the bank.
You can build the PMI into your interest rate via lender-paid mortgage insurance, which might be cheaper than paying the premium separately every month. Be sure to weigh both options.
Mortgage Rates Higher on Low Down Payment Loans
Again, we’re talking about more risk for the lender, and less of your own money, so you must pay for that convenience.
Generally speaking, the less you put down, the higher your interest rate will be, all other things being equal. And a larger loan amount will also equate to a higher mortgage payment.
So you should certainly compare different loan amounts and both FHA and conventional options to determine which works out best for your unique situation.
Tip: Consider a combo loan, which breaks your mortgage up into two loans. Keeping the first mortgage at 80% LTV will allow you to avoid mortgage insurance and keep your interest rate at bay. Or get a gift from a family member – if you bring in say 5% down, perhaps they can come up with another 15%.