How to Buy a Home with Less than 20 Percent Down
Can you buy a house with a down payment under 20 percent of the purchase price? Yes. However, it’s important to understand you’ll probably encounter extra expenses—and there are some pros and cons to consider.
It’s a common myth that low down payments are a thing of the past. The fact is, many lenders allow this. Some (but not all) of these mortgages involve U.S. government assistance programs. For example:
• FHA Loans – The Federal Housing Administration (FHA) has less stringent credit requirements and allows for down payments as low as 3.5 percent (which can be a gift). Mortgage insurance is required for the life of the loan, if the down payment is under 10 percent. Additionally, an Upfront Mortgage Insurance Premium (UFMIP) is required, as well as a monthly Mortgage Insurance Premium (MIP) payment.
• VA Loans – The Veterans Administration (VA) offers mortgage options to U.S. veterans with zero down payment, no private mortgage insurance (PMI), and funding fees ranging from 1.25 percent to 3.3 percent.
• Navy Federal Credit Union Loan – Also provides a zero down payment option with no PMI. The 1.75 percent funding fee can be waived by accepting a 0.375 percent higher interest rate.
• USDA Rural Mortgage Guarantee Program – Intended to help low- and moderate-income applicants build, rehabilitate, improve, or relocate a dwelling in eligible rural areas. (The definition of rural is broad; applicants in many suburban markets may also be eligible.) This program requires no down payment, no PMI, a 1 percent upfront guarantee fee, and an annual guarantee fee of 0.35 percent of the loan balance.
• Private Mortgage Insurance (PMI) Backed Bank Loans – An option for down payments as low as 3 percent, with no funding fee, but stricter credit requirements.
• Lender Paid Mortgage Insurance (LPMI) Bank Loans – With a low down payment and no funding fee, this is a variation on PMI backed bank loans, but involves a lump sum payment or a higher interest rate for the life of the loan.
About These Options
Before applying for one of these loans, make sure you understand the unique terminology and features associated with them, including:
Private Mortgage Insurance (PMI)
If you apply for a conventional loan and your down payment is below 20 percent, your lender will require you to buy PMI, which protects the lender in case you end up in foreclosure. The cost will vary based on your credit score, the size of your down payment, and the insurance company you select. Shopping around could save you money. Insurance rates range from less than .5 percent to nearly 1.5 percent of the original loan amount, per year.
The lender may allow you to wrap this into your monthly payments, or may require an up front payment. With a conventional loan, you can ask the lender to discontinue the PMI premiums once your loan balance reaches 80 percent of the original loan value.
FHA Insurance Payments
In the case of FHA loans, you will be required to pay both a lump sum mortgage insurance premium AND monthly insurance payments. Unlike conventional loans, where the PMI requirement can be waived after the loan balance drops below 80 percent of the original loan value, FHA’s monthly insurance requirement continues for the life of the loan (or for 11 years if your down payment was at least 10 percent).
Lender Paid Mortgage Insurance
The name is a bit misleading, since the lender doesn’t really pay your mortgage insurance FOR you. Instead, a higher interest rate (usually 0.25 to 0.5 percent) is paid to cover the cost of PMI, for the life of the loan.
Some lenders allow you to make a lump sum payment to purchase the mortgage insurance on the front end of the loan. Either way, you are still paying for the insurance, but it may (or may not) be less than paying PMI on a monthly basis.
Funding fees, as seen in loans offered by the VA and Navy Federal Credit Union, are fees paid by all borrowers that help cover losses incurred by the organization on any loans that go into default. They are usually reduced with larger down payments, or an increase in interest rate.
The USDA uses an upfront guarantee fee, as well as a monthly guarantee fee on its loans. Similar to funding fees, this refers to the USDA’s loan backing, which allows lenders to issue loans based on USDA’s guidelines.