When you buy a home, you’re typically expected to put at least 3 percent down on the house. But what happens if you don’t have thousands of dollars to give a lender a large down payment? There are down payment assistance programs that can help cover this expense so that you can get into a home.
What Is a Down Payment?
Unless you can afford to pay cash for a home purchase, you need to take out a loan to cover the expense. But while lenders are willing to cover hundreds of thousands of dollars at the outset, they want you to have a little money in the game, as well. This is where a down payment comes in.
A down payment is a non-refundable deposit from you, the borrower, that reduces the amount the lender is letting you borrow. It’s calculated as a percentage of the home's purchase price and can range from 3 to 20 percent. You make this payment at closing, usually in the form of a wire transfer or cashier’s check.
Typical Down Payment Amounts
Lenders have the freedom to set their down payment requirements. But your down payment requirement depends on your credit score, your debt-to-income ratio and the purchase price of the home you’re buying. Conventional lenders like to see a credit score of at least 580 and debt that’s 43 percent of your income or less, but with a loan backed by the Federal Housing Administration, there may be a little wiggle room.
With a conventional loan, down payments go as low as 3 percent, but you need stellar credit. More often, you’ll see 5 or 10 percent requirements. FHA loans can go as low as 3.5 percent with credit and debt-to-income ratio requirements being less strict. If you put down less than 20 percent, you’re required to pay private mortgage insurance, which is a fee that's added to each monthly payment.
Down Payment Loans
Lenders are very specific on the funds you can use for a down payment. You can take the money as a gift from a loved one, but not as a loan. You can also use savings or take money out of your retirement plans to fund it. But if you’re offered a third-party loan for your down payment, you need to check with your lender to see if it’s an acceptable source of funds.
There are several down payment assistance programs available that can help you get into a home for less. Most are geared toward first-time homebuyers or those buying in qualifying areas, so you may not be eligible for any of them.
Here are some of the best-known programs:
- USDA Loans: The USDA offers 100 percent financing to buyers who are interested in living in eligible areas. This program targets homes in more rural regions, although some suburban areas are included.
- FHA Loans: With an Federal Housing Administration loan, you can qualify with only 3.5 percent down with a lower credit score and debt-to-income ratio.
- HomeReady Mortgage: This program through Fannie Mae gets you into a home with as little as 3 percent down.
- Conventional 97: Fannie Mae and Freddie Mac back this program, which often has lower interest rates and down payment requirements than an FHA loan.
- VA Loans: If you’re a member of the military or veteran, look into loans from the Department of Veterans Affairs. You could be eligible for 100 percent financing on a home.
- Chenoa Fund Down Payment Assistance Loans: These 30-year loans offer qualifying homebuyers the funds for both conventional and FHA mortgages.
Local Down Payment Assistance
Many states offer down payment assistance to residents who qualify. These programs are designed to encourage homeownership in the state, which helps keep the economy strong while also giving people a head start. As with other mortgage programs, you may find participation is limited to first-time homebuyers or those who are buying in an area in town in need of more homeowners.
To track down payment loan programs in your state, start with your local housing authority. Although many programs are administered through lenders, a lender might not rush to tell you all about the discounts and loans you can get. By researching this ahead of time, you can gauge exactly how much money you’ll need at closing.
Consequences of Low Down Payments
If you want to borrow money to buy a home, you may need to save for months or even years to have enough for a down payment. This can be particularly tough for first-time homebuyers, especially since rent rates have continued to increase across the country. Setting money aside while struggling to pay all your bills can be tough.
The problem with a low down payment is that your monthly payment will be higher since you’re borrowing more of the amount. When you’re paying 97 percent of a $300,000 loan versus 80 percent, you’ll owe more each month, as well as a higher amount of interest. Even if you get that assistance, keep in mind that you’ll be paying more for a longer repayment period than if you’d put 10 or 20 percent down.
Getting Down Payment Assistance
Most down payment assistance programs are geared toward first-time homebuyers, but don’t count yourself out if this isn’t your first time. If you don’t qualify for federal programs, look to see if your state offers grants or loans. Each state has its own requirements for credit scores and debt-to-income ratios, but you may find local programs are less competitive.
If you’re looking into something like a USDA loan, make sure you understand the limitations before you sign up. You may find that you’re limited to an area that’s 100 miles from your office or friends and loved ones.
Understanding Private Mortgage Insurance
Low down payments have a major downside. You have to pay something called private mortgage insurance (PMI) with each monthly payment. PMI protects the lender against you defaulting on your loan, and most lenders require it on every mortgage with a lower down payment.
Both conventional and FHA loans require insurance on loans with down payments of less than 20 percent. In the case of an FHA loan, though, the insurance is called the upfront mortgage insurance premium (UFMIP). Unlike PMI, which is built into your mortgage payment, UFMIP is required upfront – usually at closing. It is typically 1.75 percent of the loan amount.
Using Piggyback Mortgages
One way to avoid those pesky mortgage insurance costs is to use something called a piggyback loan to buy your house. Also known as an 80/10/10 loan, this type of arrangement has you taking out two loans on your home with the goal of avoiding PMI. A piggyback loan gives you a primary mortgage of 80 percent, a secondary loan of 10 percent and a down payment from you of 10 percent.
Of all the loan types, the piggyback mortgage is one of the toughest to qualify for. You need to apply and be approved for two loans instead of one, so you need stellar credit. The interest rate on the 10 percent loan will be variable, so you’ll have to keep an eye on things to make sure your interest rates haven’t gone through the roof.
Read More: How to Use a HELOC for a Down Payment
Funding Closing Costs
Another big expense you face when buying a house is closing costs. Due at closing, these costs can range from 3 to 6 percent of the purchase price with a conventional loan. With an FHA loan, they average 3 to 4 percent. If you have a $300,000 loan, that’s $9,000 due at closing.
As with down payments, you can’t pay closing costs with a personal loan or any other type of borrowed funds. Here are some options for getting the money together for closing costs.
- Roll them into the mortgage: Some lenders will let you move the closing costs into your mortgage. You’ll still be paying them, with interest, but it can at least get you into the house.
- State programs: Check locally to see if your state offers closing cost assistance to qualifying homebuyers. You can find grants and loans that will help you with those costs.
- Seller negotiation: You may be able to convince the seller to cover some or all of the closing costs. This could mean you can’t negotiate the price of the home, but if pulling together upfront money is a problem, this can be a great solution.
Funding Your Down Payment
Before a lender agrees to a home loan, you need to commit to making a down payment. The vast majority of lenders do not allow third-party loans. That means if your parents or close friends give you the money, you’re required to have them sign something stating that it was a gift and not a loan.
If saving the money to fund part of your mortgage up front isn’t an option, there are some other things you can do. If you’re in a buyer’s market, you may be able to convince the seller to pay for your down payment or closing costs. These are known as seller’s concessions, and some lenders place limits on the amount of concessions the seller can pay.
Crowdfunding Your Down Payment
Since lenders won’t let you accept loans from friends and family, only gifts, crowdfunding could be an option. Crowdfunding sites are now available that let you raise the money for a down payment. Since the money is a gift, you won’t run into trouble with your lender thinking it’s a loan.
Here are some crowdfunding sites that can help you raise money for your home’s down payment.
- Feather the Nest: This site lets you gather money toward a down payment by sharing requests for donations online. You can also link it to your wedding website to get attendees to help you fund your down payment instead of buying you a gift.
- HomeFundIt: If you’re willing to get your mortgage through CMG Financial, you can use this tool to get donations. You can also earn funds toward your down payment by shopping at participating retailers.
- GoFundMe: This crowdsourcing site is popular for helping friends with medical bills and youth causes, but it can also be used to gather funds for a down payment. You pay a fee of 2.9 percent plus $0.30 per donation, which can cut into any money you raise.
Tapping Retirement Accounts
Homebuyers often pull money from their retirement to fund a down payment on a home. This can actually work out well if you have the right kind of account. If you have a Traditional or Roth IRA, first-time homebuyers are allowed to pull money out for a home purchase. With a Roth IRA, you need to have had the account for at least five years for tax-free withdrawals, while a Traditional IRA lets you take out up to $10,000 penalty-free, although you will pay income tax.
If your retirement savings is in 401(k) form, you need to check with your plan sponsor to see if withdrawals for home purchases are allowed. However, you pay a 10 percent penalty in addition to income taxes on the money you withdraw. You also need to check on the requirements for repaying the money.
Whichever retirement account you have though, it’s important to crunch the numbers on withdrawing funds from your retirement savings. Not only will you owe taxes on the money, but you also miss out on any interest you would have earned on the money during the time it was out of the account. Still, if getting into a house is a good financial move for you at the moment, you may find that the equity you build in your house makes the consequences well worth it.
Both first-time homebuyers and those who own a home can find it a struggle to save up enough for a down payment. Down payment assistance programs can help you reduce the amount you need to close on a mortgage loan. Take a look at all the options and choose a grant or loan that will help you get into a home without pushing your loan balance or monthly mortgage payments too high.
- Consumer Financial Protection Bureau: Determine Your Down Payment
- USDA: Single Family Housing Guaranteed Loan Program
- Chenoa Fund: Providing Down Payment Assistance On FHA and Conventional Loans
- Office of the Comptroller of the Currency: What Is Private Mortgage Insurance (PMI)?
- HUD.gov: Appendix 1.0 – Mortgage Insurance Premiums
- HUD.gov: Common Questions From First-Time Homebuyers
- U.S. Department of Veterans Affairs: VA Funding Fee and Loan Closing Costs
Stephanie Faris has written about finance for entrepreneurs and marketing firms since 2013. She spent nearly a year as a ghostwriter for a credit card processing service and has ghostwritten about finance for numerous marketing firms and entrepreneurs. Her work has appeared on The Motley Fool, MoneyGeek, Ecommerce Insiders, GoBankingRates, and ThriveBy30.