If you’re thinking about financing a home, you’ve probably heard of the 20% down payment rule. But what does it really take to buy a house?
A case for down payments
A down payment is the money you bring in when you finance a large purchase, like a car or a house. In general, the higher the down payment for any large purchase, the better, for several reasons:
- You will immediately own more of your assets: When it comes to a home, the equity you have is the part you paid off. So if you put in 20% of the funds, you have that much equity right away. Plus, you are much closer to owning your home.
- You’ll pay less interest over time: Interest is a percentage calculated on the amount of money you borrow, so if you borrow less, you pay less total interest.
- You can get better interest rates: When you have money or an asset to borrow against, you are essentially less risky for potential lenders. For this reason, you are more likely to get a lower interest rate on a mortgage the more money you put in.
- You will be more competitive compared to other buyers: If you’re ready to go with the cash, you’ll likely look more attractive to a lender and seller than someone who needs more help.
- You can waive the PMI (Private Mortgage Insurance): Typically, lenders will require private mortgage insurance if your down payment is less than 20%. It might not matter to you if you have a good monthly cash flow, but just don’t have a large amount of cash to use as a down payment. Also note that lenders normally lower the PMI once you reach 20% equity.
Related: Tips for saving a down payment
How much do you need to deposit?
The absolute minimum down payment required ultimately depends on several factors, such as the type of loan you get, your lender, your credit score, or your debt-to-income ratio. A conventional lender typically requires at least 3% down payment, but may ask for more if your credit score is below a certain threshold or if your debt-to-income ratio is high.
Government guaranteed loans like VA, USDA, or FHA loans will require little or no down payment as they have other qualifying factors. If you are a current or former member of the United States Armed Forces or National Guard, you are eligible for a VA loan (backed by the Department of Veterans Affairs) that does not require a down payment. Likewise, the United States Department of Agriculture does not support any down payment in certain areas of the country. And the Federal Housing Authority offers options for lower credit scores and first-time home buyers in an effort to expand homeownership. The down payment requirement is 3% and you can often factor closing costs into your loan.
In general, the higher your down payment the better, but research shows that the average down payment in the United States is around 6%, and it can go down because of what people can afford with rising housing costs. The 20% rule (or myth) that we often hear is something that stems from the private mortgage insurance requirement.
Related: How much down payment do you need to buy a house?
Ways to make down payments
Not everyone has thousands of dollars on hand, and the cruel irony is that getting a mortgage to buy a home can improve your long-term financial health. If you are planning on trying to make a down payment, there are other options besides pinching pennies for years and years.
Government guaranteed loans
As mentioned above, there are several government guaranteed loan options to help you get a home without a down payment, such as VA loans and USDA loans. If you are an active or former member of the military, be sure to review VA loans and similarly check if your property is eligible for a USDA loan.
Down payment assistance
Don’t limit yourself to federally guaranteed loans; many states also offer down payment assistance for first-time home buyers. There are some good government backed options out there, but there are also nonprofits and private lenders who want to help out as well. Most states have consolidated lists of options, but a quick web search would tell you what options are available near you.
Ask a good friend / family member
Maybe you have someone close who would be willing and able to help you with a down payment, either as a gift or with an agreement to return the money. If a good mortgage rate and good equity are helping you prepare for a healthy financial future, their investment is likely to pay off, and it may be worth asking someone to help you.
Related: Can you put a deposit on a credit card?
Get your finances in order
It’s easier said than done, but getting your finances in order will go far beyond getting a mortgage or a down payment – it will help you finance your finances. mortgage payments and continue to grow your wealth. Even if you don’t plan on making your down payment the old fashioned way, try to get your finances in order. Lower your credit card balances, pay off loans, cut expenses, and even look for sustainable ways to earn extra income. Building good habits will not only help you get a home, but they will also continue to benefit you once you have to pay off a mortgage.
While the concept of 20% down isn’t exactly a myth, it isn’t necessarily necessary to get a home, either. If you have a few thousand savings that don’t amount to 20%, you will probably still be able to get a mortgage if you have good credit and low debt.
And if you don’t have the money for even a small percentage, there are always options for you. Whether you are making a down payment or not, a purchase as large as a home requires some planning and thought. Do your research and consider all of your options.