If you’re thinking about buying a house soon, there are no doubt plenty of questions that have crossed your mind. One of those questions is probably whether or not you have enough saved for a down payment.
There are many low and even zero down payment options you may qualify for. But, your friends say, it makes more sense to wait until you have 20% for a down payment. It’s true that there are advantages to making a higher down payment. However, buying now can make sense as well. There are trade-offs to each option.
If you’re thinking about buying a home soon, this post will take you through the alternatives. But first, let’s define how much you really need for a down payment.
How Much Do You Need for a Down Payment?
The conventional wisdom used to be that you needed to save 20% for a down payment. While this may have been true when our parents or grandparents were buying their first home, it’s no longer the case.
If you get a conventional loan with a median FICO® Score of 620 or higher, you can get a loan with as little as 3% down. For context, on a $250,000 loan, the down payment would be $7,500. It’s not a small sum, but it’s very attainable in a reasonable period of time with diligent saving.
While the lowest down payment options come with some restrictions in terms of qualifying income limits, it’s worth noting that if you’re getting a primary property with a conventional loan, in no event will you be required to have more than 5% for a down payment under current guidelines.
If you get an FHA loan, you may be able to qualify for a mortgage with a median FICO Score of 580 or higher and a down payment as low as 3.5%. One thing to note is that in order to qualify with a credit score that low, you’ll need to maintain a low debt-to-income ratio (DTI), which could affect the type of home you can afford. However, one of the advantages to an FHA loan is that you can qualify with a higher DTI if you have a higher median FICO Score.
For the same $250,000 loan, you would need $8,750 to get an FHA loan. Check out this post for more information on the difference between conventional and FHA loans.
There are a couple of zero-down payment options available. If you have a median FICO Score of 640 or higher and live in a rural area or on the outskirts of suburbia, among other requirements, it might be worth looking in to a USDA loan.
Finally, if you’re an eligible active-duty service member, veteran or surviving spouse of someone who passed in the line of duty or as a result of a service-connected disability, you may be eligible to take advantage of a VA loan with a 0% down payment.
Additionally, where other loans have mortgage insurance or an equivalent (more on that below), VA loans have a one-time funding fee that can be rolled into the loan amount. If you did choose to pay it up front at closing, the funding fee is 2.15% for your first VA loan as a qualifying active-duty servicemember or veteran and 2.4% as an eligible reservist. To pay the funding fee upfront on a $250,000 loan, it would be $5,375 or $6,000 depending on which category you fell into. If you receive VA disability payments or are a surviving spouse, the funding fee is waived.
Now that you know exactly how much you need, let’s go over the advantages and disadvantages of lower and higher down payments.
Lower Down Payment
Let’s break this scenario down by its advantages and disadvantages.
The most obvious advantage of a lower down payment almost doesn’t need to be said, but I’m going to say it anyway. A lower upfront investment will enable you to get in to a home of your own sooner. Also, in hot markets, this could provide a way for you to get in to a home and make a competitive offer so that you don’t deal with constantly rising apartment rent.
If you have more money saved, you still may want to take a lower down payment if you also need to buy furniture or put a little bit of work in to the house to make it exactly the way you want it.
Since mortgage interest rates are often lower than the rates of return you might see from other investments, an investor might choose to make a lower down payment to free up more of their money to invest in other areas.
While there are advantages to a lower down payment, it isn’t without its drawbacks.
Lenders and mortgage investors take your down payment as one indicator of the risk involved in your loan. The lower your down payment, the bigger the loan has to be. The people invested in your loan also want to see that you have something at stake. The more you put out up front, the more you stand to lose by walking away at the first sign of financial struggle, so you’re less likely to default.
To account for this risk, lenders put into place a loan-level price adjustment (LLPA), meaning you’ll get a rate that’s a certain percentage higher than the one set at the base market level based on the size of your down payment.
Another precaution lenders and mortgage investors take to mitigate risk with a low down payment is requiring a mortgage insurance policy. The insurance carrier pays the lender or mortgage investor if you default on your loan.
If you’re getting a conventional loan, you’ll have to pay for private mortgage insurance (PMI) if you put down less than 20%. There are two forms of mortgage insurance – borrower-paid and lender-paid mortgage insurance.
Borrower-paid mortgage insurance (BPMI) is pretty straightforward. You’re charged a certain annual premium based on your down payment size and your FICO Score. This annual premium is split into monthly installments that are added to your mortgage payment.
Lender-paid mortgage insurance (LPMI) is an arrangement in which the lender pays for the mortgage insurance policy up front, thus avoiding a monthly mortgage insurance payment for the borrower. From there, the arrangement breaks down a couple of different ways.
One type of LPMI involves an LLPA where the borrower gets a higher rate than they would if the lender didn’t pay up front for the mortgage insurance policy. The second type is sometimes referred to as single-pay mortgage insurance. In this case, the client pays for all or a portion of the policy up front at closing in order to get all the benefits of a lower rate without the mortgage insurance payment.
Although PMI helps relieve some of the risks so that lenders can give you a mortgage with a lower down payment, no one likes paying more than they have to. The good news is Quicken Loans offers some of the lowest available rates for both BPMI and LPMI.1
With FHA loans, unless you make a down payment of 10% or more, you’re going to have to pay mortgage insurance premiums (MIP) for the life of the loan. Otherwise, you pay MIP for 11 years. There’s an upfront premium that can be paid at close or rolled into the loan as well as annual premiums split into monthly payments.
The upfront premium is currently 1.75% of the loan amount. The amount of your annual premium is dependent on the exact size of your down payment as well as your loan amount. But if you make the minimum down payment on a loan of no more than $625,500, the annual premium is 0.85% of the loan amount divided into monthly installments.
On USDA loans, the equivalent of mortgage insurance is the guarantee fee. Guarantee fees stick around for as long as you have a USDA loan no matter the size of your down payment. There’s an upfront guarantee fee of 1% of the loan amount that can be built into the loan. The annual premium is 0.35% apportioned in monthly payments.
If you want to avoid paying mortgage insurance forever, you can look to refinance into a conventional loan once you reach 20% equity in your home and you wouldn’t have to pay mortgage insurance again.
Higher Down Payment
If you can afford to make a higher down payment, there are pros and cons to that as well.
In terms of the benefits of a higher down payment, you’ll be getting a better rate because it means less risk for the lender.
If you have 20% down on a conventional loan, you can avoid paying mortgage insurance at all, which cuts down on your monthly payment. Even if you don’t make a full 20% down payment, PMI rates get lower the bigger your down payment is.
If you can afford to make a higher down payment, the reasons above are as good as any to do so. However, there are two snags to at least be aware of.
The first downside is that it could take you longer to get into your home. If you’re looking to get out of your apartment as soon as possible, saving 20% may not be feasible.
Finally, if you’re putting that much money up front in your house, you may not have it for other things like home improvements or other investments. You’re tying up some of your cash in the home, so it’s important to be aware of the trade-offs.
If you think you’re ready to move forward, you can get started online or give one of our Home Loan Experts a call at (800) 785-4788. If you have any questions, you can leave them for us in the comments below.
1 BPMI monthly and LPMI single rate data is compared to publicly published private mortgage insurance rates.
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