Alternatives to Putting 20 Percent Down on a Home
It's a mantra often repeated in the real estate industry: If you want to buy a house, you need a 20 percent down payment. But with the average house in the U.S. costing $311,400 as of December 2013, according to the Census Bureau, all one has to do is the math to get a coronary. Raising a 20 percent down payment isn't an easy thing to do.
Fortunately, you don't have to. "It's a myth that all homebuyers must have a 20 percent down payment to buy a home," says Nancy Herrera-Siples, a Riverside, Calif., branch manager at Primary Residential Mortgage.
"Putting less than 20 percent is OK with most banks," agrees Christopher Pepe, president of Pepe Real Estate in Brooklyn, N.Y. So why do you constantly hear that you need to put 20 percent%VIRTUAL-pullquote-"Don't pick a property and then work backward toward financing. You'll only frustrate yourself."% down? Because if you don't, it usually means you'll have to shell out money for either private mortgage insurance or government insurance, which is usually financed by the Federal Housing Administration. Mortgage insurance protects the lender in case you can't make your payments and the house is foreclosed on. But PMI payments don't last forever. When your loan-to-value ratio is 80 percent, you can ask the lender if you can stop paying PMI; at 78 percent, the lender is required to cancel it.
Still, PMI can easily cost a couple hundred dollars a month, assuming your house is valued in the neighborhood of $200,000. Pepe says the average he sees is $700 a month just for PMI. But keep in mind that he's based in New York City, which boasts one of the highest costs of living in the country.
So if you really want a house and you're looking for alternatives to putting 20 percent down, here's what you need to know.
Figure out financing before looking for a house. There are numerous programs that will help you buy a home without 20 percent down, says Dan Smith, president of Private Mortgage Solutions, a mortgage bank in Atlanta. But, Smith adds, "All of these programs have various lender, property and borrower qualify requirements and restrictions. A knowledgeable mortgage banker or mortgage originator should be able to provide assistance and details."
You'll have to hook up with a lender eventually, and Smith suggests doing it early. "Don't pick a property and then work backward toward financing," he advises. "You'll only frustrate yourself."
Another reason to have a mortgage banker in your corner: "Lenders can layer programs to help each borrower overcome dilemmas," Herrera-Siples says, citing common problems like not having a down payment or needing lower monthly payments.
Try your own bank first. This is advisable especially if you have a good relationship with the bank, says Amanda Monette, a real estate lending officer with Rockford Bank & Trust in Rockford, Ill. "You may have a better shot of getting a loan, even if you don't have the money for a down payment."
If you do all of your banking at your local bank, including investments and a savings account, Monette says this will work your favor. "Extra points," she says, "if your parents, grandparents and other relatives bank with the same institution as you do. A banker may be more willing to go the extra mile because he or she knows you and your family and knows that you will be a good risk."
Some common but unconventional routes you might take. "There are a variety of options available to consumers," Smith says, citing the FHA, which offers mortgages in which the homeowner can put as little as 3.5 percent down. "The [U.S. Department of Agriculture] offers a program that allows buyers to purchase a qualified property with zero down. And many conventional leaders will allow subordinate financing to bridge the gap between the down payment and first mortgage loan amount."
But, of course, there's no free lunch, and some of these unconventional roads lead to an expensive toll booth. For instance, FHA loans, which were once considered great loans for first-time, low-income homebuyers, are much more expensive than they used to be because of mortgage insurance. With subordinate financing, you're taking out another loan to make up for not having the 20 percent down payment, and the second loan often has a higher interest rate than the first. Make sure the math works out so that you're not paying more in the long run than if you paid the PMI.
USDA loans, available for people who want to purchase a home in an area considered rural, are generally still well-regarded and coveted by many homeowners with incomes considered low to moderate. There are a range of limits depending on the type of USDA loan you're eligible for and state you live in, as well as a lot of criteria to meet. For example, if you are part of a Colorado family with one to four people and a household income of around $70,000 or less, you'd probably qualify.
Check with your state. While you're figuring out how to finance your home, don't forget that your state may have loan programs to help homeowners – especially first-time buyers.
For instance, Illinois recently announced its "Welcome Home Illinois" program, in which first-time buyers or people who haven't owned a house in Illinois within three years can get $7,500 in down payment assistance with an interest rate as low as 3.99 percent for a 30-year fixed rate mortgage. It's aimed at working class families -– a family of three in Chicago can earn as much as $106,000 in annual household income and qualify. In other parts of the state where the cost of living is lower, the same family of three can earn no more than $82,915 to qualify. And the homebuyer must have a credit score of at least 640.
Whatever you do, don't get too cute. If you don't have the 20 percent, it may be best to keep saving until you reach that amount, or at least get closer to it. Just because you find a way to finance your move-in doesn't mean you should take it. You want have enough left over in your budget to enjoy your house, not worry every month about how you're going to pay the mortgage. In other words, you can live under a roof without 20 percent down –- but is the alternative something you can live with?