When we bought our first home back in 1993, we did so with a down payment of five percent. A few years ago, you could find home loans that didn’t require any down payment. Since the real estate market crash, lenders have tightened their underwriting requirements again, and zero-down loans are for the most part a thing of the past. So how big of a down payment do you need to buy a home?
It’s an important question, particularly as more and more people are looking to buy. Home loan rates are at an all-time low, and real estate values are likely near the bottom. So what’s the answer?
Generally speaking, you’ll need a down payment of at least three to five percent. There are a variety of programs that, if you qualify, offer low-interest mortgages that require a smaller down payment. Although most private lenders like to see a down payment equal to 20% or more (if you can’t come up with 20% you need PMI), the Federal Housing Administration (FHA) provides loans to certain home buyers who are able to put down at least 3.5% of the home’s cost. And the Department of Veterans Affairs (VA) provides home loans with no down payment for most veterans.
Let’s look at the details.
VA Loans–0% Down Payment
Mortgages guaranteed by the Department of Veterans Affairs are, as a practical matter, the only zero-down mortgages available. If you qualify, a VA loan is an excellent option. VA loans can be used not only to buy a home, but also to repair a home or refinance an existing mortgage. You can find the eligibilty requirements on the VA’s website here.
HomePath–3% Down Payment
HomePath is a financing program available when you purchase a home owned by Fannie Mae. And just to be clear, Fannie Mae owns homes that have gone through the foreclosure process. I’ve purchased 5 foreclosures as investments, and walked through dozens of foreclosures in the process. Some homes remind you of the basement in Silence of the Lambs, while others are in excellent condition. So it may take some time to find the right home, but it can be worth the effort.
There are two big benefits of HomePath loans. First, the down payment requirement is just three percent. Second, there is not private mortgage insurance required. You can get more details at Fannie Mae’s HomePath website.
FHA Loan–3.5% Down Payment
If you qualify, you can purchase a home with an FHA loan with a down payment of just 3.5 percent. Unlike HomePath loans, however, mortgage insurance is required. But it’s still a great deal if you don’t have a larger down payment.
Conventional Loans–5% Down Payment
If you don’t qualify for one of the above government guarantee programs, you are likely looking at a down payment of at least five percent. And of course, this doesn’t include other closing costs that you’ll either need to pay or negotiate with the seller to pay.
Keep in mind, however, that for down payments of less than 20%, you will pay private mortgage insurance (PMI). PMI is insurance that protects the lender for up to 20 percent of the purchase price and is paid monthly as part of your mortgage payment. For example, if you paid a 3 percent down payment on a $100,000 home, PMI would guarantee $17,000 of the loan. As a result, the premium you must pay varies according to the size of your down payment.
Here are typical rates:
For example, let’s say you buy a $100,000 home and put 5% down. Your down payment is $5,000 and the mortgage is $95,000. Divide the $95,000 mortgage by 1,500 and you get your monthly PMI cost, $63.
Make sure you understand the pros and cons of making a larger vs. a smaller down payment and the need for PMI. Avoiding PMI if you can is best, but you also don’t want to spend every last dime you have on a down payment. And in fact, most lenders won’t let you. As part of the underwriting process, they will want to see that you have some money in the bank to cover unexpected costs. And that’s just one more reason an emergency fund is so important.