Last Updated on June 14, 2023 by Bob Filipczak
The recommended down payment on a house in the U.S. is a hotly debated topic. If you are old school, it’s 20%. If you are a first-home buyer, that’s a rather big hurdle. It makes the prospect of owning a home seem out of reach. There’s good news: there is no one answer to the question of what kind of down payment you need for a house. It all depends. Let’s look at some of the factors that can affect your down payment.
It’s important to remember that mortgage lenders want your business and they can be somewhat flexible. If, for example, you don’t have enough cash for a 20% down payment but you’ve got a great credit score and steady paycheck, they may be willing to negotiate. Here are some of the questions you may have about making that down payment.
Why 20 Percent is Often a Recommended Down Payment on a House
There are certain benefits when you go with a 20 percent recommended down payment on a house. The traditional 20% is probably the most commonly recommended down payment on a house in the U.S. This is because a 20% down payment often allows you to avoid paying Private Mortgage Insurance (PMI), which is a type of insurance that protects the lender if you default on the loan.
PMI can affect your monthly mortgage payment. It’s usually folded into your monthly payment and can run between $125 – $375 a month. By putting 20% down, you avoid that hit every month. Also, with a larger down payment, your total mortgage amount will be less, which will also help to minimize your monthly payments in the long run.
Mortgage Lenders feel less risk when you have 20% down, so that lump sum makes the transaction flow much smoother. For example, if you put down 20%, you can often get better interest rates by buying down points. That means you can reduce your overall interest rate on your mortgage loan, saving you money each month and over the life of your loan.
Typically, people who already own a home and want to buy a new home can afford the 20% down. Right now homeowners are sitting on more home equity than ever, with the average household equity at a record high of $320,000. Recent research shows that it’s gone up by an additional $60,000 in the past year.
What is the Recommended Down Payment on a House If Unable to Pay 20 Percent?
Simply put, you pursue other options you can afford. Remember, when financing a down payment on a house:
- The median down payment on a home is 13 percent
- The median down payment for buyers aged 23-31 is around 8 percent
- The average down payment for first-time home buyer loans is 6 percent
This is why there is no standard recommended down payment on a house, because it really does depend on your own situation. Mortgages are approved for home buyers who typically put down anywhere from 3.5% – 20% depending upon the home buyers circumstances and they type of loan they use, so keep that in mind. If you are new to the world of buying a home, mortgage lenders will recognize that and try to help you as much as possible. As we said before, having other factors like a good (or great) credit score, can help.
A good employment history also weighs in your favor. Lenders will also look at your DTI or debt-to-income ratio. That’s a percentage of your total monthly earnings calculated against your regular monthly debts. As a rule, you want your DTI below 41%.
What if, however, you’ve got zero in your savings account but still want to buy a home? There are some other sources of funds that can help you get a conventional mortgage.
You Can Use Gift Funds
Homebuyers can consider accepting gift funds from relatives or dear friends to aid in their down payment. Whether or not this is permissible is subject to the mortgage lender’s discretion, so it’s best to have an early conversation about this. With specific guidelines and rules pertaining to gift funds, doing thorough research is advisable. Lenders usually ask for a gift letter and evidence to confirm that the funds are indeed a gift and not a loan.
You Can Co-Borrow
Co-borrowing presents another alternative when deliberating on down payment options. It involves collaborating with a trusted individual, such as a kin or a close friend, in order to jointly purchase a property. Co-borrowers can merge their down payments, thus bolstering their buying power and potentially expediting the journey towards homeownership. Contrary to being a loan cosigner, co-borrowing implies that both parties have a stake in the property, regardless of who actually resides there.
You Can Use Retirement Funds for Down Payment
One of the most advisable ways to use a retirement fund or 401(K) for down payment is by borrowing from it. If you opt to withdraw and directly spend the money, you will be hit with a 10% penalty by the IRS, unless you are above 59 years of age. If you choose to borrow from the fund, you can repay it over time, thus dodging the penalty.
In the case of an employer-backed retirement fund, it’s recommended to confirm with your employer about the regulations for borrowing from the plan. Typically, they might only permit you to borrow a certain percentage of the retirement fund, depending on your vesting status.
If I’m Looking For Programs That Will Help Me Make a Down Payment…
…then you have a couple of options. On the federal government side, there is the FHA loan.
An FHA home loan, insured by the Federal Housing Administration and provided by a certified lender, is crafted to cater to low to moderate-income earners who may also have lower credit scores. The dual advantages of a reduced down payment and relaxed credit criteria make FHA loans an optimal choice. Here are some of the benefits:
- Low Down Payment – The FHA mandates minimum down payment requirements of 3.5% of the entire home loan. This down payment percentage might fluctuate if your credit score is below 580.
- Relaxed Approval Criteria – The qualification requirements are less stringent compared to those of conventional loans.
- Lower Credit Scores – If you have a lower credit score and are unable to secure a loan from traditional lenders, the FHA loan is made for your situation.
- More than Just First-Time Home Buyers – The FHA program extends its benefits to all, not exclusively first-time home buyers.
If 3% down sounds attractive, then you also have some conventional loan options from private lenders. These mortgage loans are called the Conventional 97. These types of loans come from Fannie Mae and Freddie Mac but most private lenders offer them, and there are four mortgage options.
- Fannie Mae HomeReady Loans are for buyers with lower incomes who have a minimum credit score of 620 or better. They must also complete homebuyer counseling.
- Fannie Mae 97% LTC Standard loans help first-time homebuyers with credit scores higher than 620.
- Freddie Mac Home Possible Loans are available for those with credit scores of 660 or higher. The homes must be in underserved areas, and applicants must have an income below a set limit.
- Freddie Mac Home One loans are for first-time homebuyers who enroll in and complete a homebuyer education course. These loans are available for single-unit homes that the will be a primary residence.
If I’m Looking for Programs With No Down Payment…
…there are two of them and both are government-backed loans. If you have been in the military, you should definitely check out the VA Loan Program from the U.S. Department of Veteran Affairs. Both active duty military and military veterans are eligible. The benefits of the VA loan are substantial. First and foremost, with the VA loan guarantee, you will have no down payment.
In addition, VA loans come with reduced mortgage interest rates and private mortgage insurance is completely waived. These three benefits can save you thousands up front and tens of thousands of dollars over the life of the mortgage. For more information, we have a complete list of VA loan benefits.
If you have not been in the military, there is one other no-down-payment option: the USDA Loan Program.
This national program is for anyone who wishes to buy a home in a rural area. These loan guarantees have no down payment. The loans are guaranteed and insured by the USDA, while the loans themselves come from private lenders and banks. What’s rural, exactly? The USDA defines “rural areas” as towns with a population of less than 35,000 people, and that includes 97% of the United States.
If you want to buy a home in a rural area, you can find out if the area is eligible for USDA loans by checking their map.
The USDA loan guarantee does have limitations for income levels and are reserved for those with moderate or lower incomes. The eligibility for these loans is spelled out clearly.
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