In the past, lenders usually required a down payment of at least 20 percent of the purchase price of a home. Nowadays that’s no longer the case. Instead, the amount of your down payment will depend on a variety of factors, such as the amount of money you have saved for your home purchase, your current financial situation, and your feelings toward other investment options.
Can you get a low down payment mortgage?
Today, many lenders are approving loans with lower down payments. In addition, certain private and government entities have low down payment programs.
Tip: For 2004 through 2007, the American Dream Downpayment Act provides grants for down payment and/or closing cost assistance to low- and moderate-income first-time homebuyers. The program will be administered through the U.S. Housing and Urban Development (HUD) HOME Investment Partnership program.
You may be able to get a Federal Housing Administration (FHA) mortgage with a down payment of as little as 3 percent. Qualification standards are relatively lenient for FHA mortgages, and the terms of these mortgages are generally very attractive, making them ideal for first-time homebuyers. Keep in mind, however, that FHA loans require borrowers to pay mortgage insurance premiums.
Department of Veterans Affairs (VA) mortgages are another low down payment option. VA mortgages are available to qualified veterans and their surviving spouses. VA mortgage terms are also generally very attractive, and in many cases, little or no down payment is required.
You may be able to obtain a conventional mortgage with a down payment of less than 20 percent with the help of private mortgage insurance (PMI). Low down payment mortgages are somewhat risky for lenders, because they believe you are more likely to default on a loan in which you have very little invested. For this reason, lenders generally require PMI if you are borrowing more than 80 percent of the value of the home you are purchasing (i.e., your down payment is less than 20 percent).
If you are concerned about taking on PMI payments, keep in mind that you may not have to pay PMI forever. For loans originated after July 29, 1999, your lender is obligated to cancel your PMI once you have reached 22 percent equity in your home, provided you have a good payment history. Or, you can petition your lender to remove the PMI if you have a good payment history and reach 20 percent equity in your home.
Tip: In addition to requiring PMI, lenders sometimes have stricter qualification standards and offer lower loan limits and higher interest rates if your down payment is less than 20 percent.
If you don’t have at least 20 percent for a down payment, consider asking if your lender would be willing to increase your mortgage interest rate a quarter of a point rather than require PMI coverage. Your monthly payment will increase by roughly the same amount as the monthly insurance premium. However, mortgage interest is generally tax deductible; PMI payments are not.
Tip: If you opt to pay a higher interest rate instead of taking on PMI, remember that you may be able to cancel your PMI sometime in the future, whereas you’ll have to pay the higher interest rate until the mortgage is paid off or you refinance.
Another alternative to PMI is to obtain 80-10-10 financing, where a lender provides a traditional 80 percent first mortgage, and you then obtain a 10 percent second mortgage and make a 10 percent down payment.
What about larger down payments?
If you have more than 20 percent to put down, you may still want to take the time to weigh your down payment options. With a larger down payment, you will reduce the amount of your mortgage and thus the amount of interest you will pay. And since a larger down payment usually means less risk, lenders often offer lower interest rates and are more lenient toward borrowers who provide larger down payments. Also, a larger down payment gives you instant equity in your home, which can be accessed through a home equity loan or home equity line of credit.
Keep in mind, however, that there may be situations where you might not want to make a large down payment. For example, you may want to keep the money in your emergency cash reserve. Or, you may want to put the money toward other investment opportunities.
What about mortgages that don’t require a down payment?
Some lenders offer “no down payment” or “100 percent financing” mortgage programs. However, these programs typically have high interest rates and closing costs, along with additional qualification requirements.
Investing money for a down payment
If you’re saving for a down payment, you may be wondering where you should invest your money. The answer depends on how soon you’ll need the money, since the more time you have, the more risk you may be willing to accept in considering investments. If you’re going to need the down payment within the next few years, you’ll probably want to minimize risk. For many, this means a bank savings account. However, you’ll also want to consider money market accounts as well. Money market accounts are low-risk, and generally pay slightly higher interest rates than bank savings accounts.