How to Determine What you Need for a Down Payment
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Once of the most common questions I get in regards to real estate, is how to determine what is needed for a down payment. Years ago the golden rule was 20%, but things have changed. You can now purchase a home with as little as 3% down, and even 0% down in some cases! It all depends on the loan you qualify for.
So in order to know what you qualify for, your first step in the home buying process should be to talk with a mortgage lender. They will be able to get you started in the right direction. For starters here are four of the most common residential home loan options available to buyers.
Conventional
A conventional loan is great way to go and involves less loan stipulations then a government backed loan. If you are a first time home buyer, you can quality for as little as 3% down. If you are not a first time home buyer you can still qualify to 5% down. What you qualify for is dependent on things such as your credit score and debt to income.
With a conventional loan, you can ask for up to 6% sellers assist. The sellers assist is based off of the offer price and is given back to the buyer to help with closing costs. For example, if you placed an offer of $100,000 and asked for 6% sellers assist, the sellers would provide $6,000 to you at closing so it is less cash you will need to purchase the home.
Another thing to note is that anytime you put less than 20% down on a home, you will have to pay private mortgage insurance also known as PMI. The amount you pay in PMI is determined based on your risk assessment including credit score and debt to income. The better these numbers are, the lower your PMI. And PMI is not typically anything crazy. Anywhere from $30-$75 is pretty typical. Once you gain 20% ownership in the home, the PMI will drop off and you will no longer have to pay it.
FHA
FHA or ‘Federal Housing Administration’ loans are government backed loans. These loans allow for 3.5% down payment. Unlike a conventional first time home buyer loan that you can only quality for once, an FHA loan can be used again, even if its not your first home.
Since FHA is such a low down payment, homeowners will be required to pay a PMI. Unlike a conventional loan where once you reach 20% ownership PMI drops off, with an FHA loan PMI remains on for the life of the loan. Therefore the only way to get rid of PMI once you hit 20% ownership is to refinance. Also the PMI on an FHA loan is not risk based as it is with conventional. With a government backed loan, the PMI is a constant rate regardless of your credit score or debt to income.
Another important requirement to keep in mind with FHA and all government backed loans is their housing requirements. Unlike a conventional loan, government loans require certain specifications such as no chipped or peeling paint, all stairs must have handrails, GFCI outlets, smoke detectors, and pressure relief valve on the hot water tank. The house must also be in working and livable condition. If you are missing a stair, or the furnace does not work, the home will not qualify for an FHA loan. In order to qualify, all items must meet FHA guidelines prior to purchasing the home.
USDA
USDA loans (US Department of Agriculture) are loans with 0% down payment if the home is eligible. As you could guess from the name, the USDA loans typically services a rural area, although every now and then you can find homes in town that qualify. In order to know if a home qualifies for a USDA loan, you will have to plug the address into the website.
https://eligibility.sc.egov.usda.gov/eligibility/welcomeAction.do?pageAction=sfp
The criteria for USDA loans is similar to that of FHA when it comes to actual home requirements. Everything needs to be in working order, no chipped or peeling paint, handrails, etc. If a home meets those specifications, there are also criteria the buyer needs to meet. USDA loans are very strict about debt to income ratios. They typically look for a ratio of 29/41. There is also a maximum income guideline that is for the entire household. It is based on everyone living in the home, not just the names on the loan. Lastly, they do require two years of tax returns for anyone living in the home.
On the plus side of things, if you and the home qualify for USDA there is no monthly PMI added to your mortgage - instead there is an annual payment which is typically less than what you would pay in PMI. An USDA loan is a great loan if you and the home are able to qualify. It’s a little bit tougher to get approved for but definitely worth the effort.
VA
A VA loan is a veterans loan; therefore in order to qualify you must be in some branch of the military. The biggest perks of a VA loan is that it requires 0% down AND no monthly PMI. Although, a VA loan does have an origination fee of 2.3% of the loan value which is tacked onto the closing costs and then financed. This fee is waived for wounded vets, and some banks do not charge it as a way to give back. But you will want to verify your lender does handle VA loans because it is not available at all banks.
Like other government backed loans, a VA loan does have a certain set of criteria that a home must meet in order to qualify. The VA loan also requires that if someone else is on the loan aside from the veteran, they must be married. Two brothers can not be on the loan nor a boyfriend and girlfriend. The individuals must be married.
Overall, meeting with your lender is the best place to start. They will be able to point you in the right direction to get started. Once you know what kind of loan you are eligible for, you will then be able to ensure the homes you are looking at will qualify for your loan program. This is why speaking with your lender first is so important to the whole home buying process. Happy house shopping!
