One of the largest roadblocks to homeownership is saving enough for the down payment. With individual savings rates at all-time lows, coming up with thousands of dollars to purchase a home can feel out of reach for many first-time homebuyers. Even when selling a home, it is possible not to net enough to pay 20% down on the next home. Fortunately, there are multiple programs available to both first time and repeat home buyers that lower down payment requirements and open the door to home ownership to more Americans.
Down Payments 101
Purchasing a home typically requires a down payment plus closing costs. When you use your money to buy a home, there is a vested interest in the property, reducing the risk of default to the lender or guarantor. Typically, when you make an offer on a home, you pay a small deposit of around $1,000. When the seller accepts the offer, the listing agent places the deposit into an escrow account to use towards any closing costs or the down payment. You pay any remaining funds due when you sign the final papers.
To lower the costs associated with purchase, you could offer a higher sales price for the house and request the seller to pay closing costs. Using this strategy essentially finances the closing costs in the loan and reduces the amount needed at closing, provided the home appraises high enough.
Most loans, without a 20% down payment, require the purchase of mortgage insurance. The insurance protects the guarantor or the bank against default and is different than the homeowner’s property insurance you must carry. Buyers pay a fee at closing (added to the closing costs) and then make monthly payments, sometimes for the life of the loan. In some cases, when you accrue 20% or more equity in the home, you can request to cancel the mortgage insurance. In other cases, you must pay the mortgage insurance until you refinance or sell the home.
Loan Programs Which Offer Buyers Lower Down Payment Requirements
Conventional home loans require 20% down plus closing costs: for example, if you are purchasing a $250,000 home, you must save $50,000. Add closing costs, which can easily be another 5% putting buying a home out of reach.
Fortunately, there are a number of loan programs that cater to individuals with less than a 20% down payment. In 2016, 40% of home buyers secured a home with a down payment of under 10%.
Here are a few of the most popular programs:
FHA (Federal Housing Administration) loans target first time home buyers, but repeat buyers can qualify. The loan features more generous terms, accepts lower credit scores, while still offering low-interest rates. You may qualify for an FHA loan with as little as 3.5% as a down payment provided it is your primary residence, and you meet the other credit parameters. Backed by the United States government, borrowers must make mortgage insurance payments as a percentage of the loan at closing, and then through ongoing monthly payments.
Conventional 97 offers home loans sponsored by Fannie Mae and Freddie Mac, which guarantees the loans. You can close a loan with as little as a 3% down payment. To qualify the home must be a single-family home and your primary residence. Buyers must have average to excellent credit to qualify.
Home Ready™ loans, guaranteed by Fannie Mae, only requires 3% down and targets primary home buyers with multi-generational families and those with below average income. This program also discounts interest rates and the cost of private mortgage insurance, saving borrowers’ money over the long run.
VA Loans give veterans and active duty military personnel the ability to buy a home with no money down. The other significant feature of this program is the waiving of mortgage insurance.
When the seller pays closing costs, veterans can purchase a home with very little in savings.
USDA Loans, also called Rural Development loans, focus on helping those living in less populated areas. The Department of Agriculture guarantees the loan and qualified buyers can receive up to 100% financing.
Piggy Back mortgage, is a common strategy used to eliminate the cost of mortgage insurance: If you qualify, you may buy a home using one of the above programs for 80% of the purchase price. Then add a second mortgage, at a higher interest rate for the remaining amount, up to the loans maximum. The higher rate of the second loan will often more than offset the elimination of the mortgage insurance, which can be well over $100 per month plus the initial fees at closing.
Creative Ways to Get a Down Payment
In most cases, you can use multiple resources to build an adequate down payment to purchase a home. In the above programs, you may save it yourself, receive a gift or loan from a family member (although if it is a loan, it will count against your debt to income), a gift from your employer, or a grant from a non-profit or government agency.
State, county, and city governments offer financial assistance for down payments with grant money through federal government programs operated by HUD (Department of Housing and Urban Development). Local Housing Finance Agencies (HFAs) execute these programs and distribute funds to qualified applicants. Qualifications often include household income limits as well as restrictions to certain zip codes or neighborhoods.
How to Receive Assistance
Receiving a government grant will require you to occupy the home as a primary residence and live there for a certain period. After meeting the requirements, the grant will not require repayment.
Another common form of aid is providing a second mortgage with deferred payments. After living in the home for the required duration, you receive loan forgiveness of the second mortgage balance.
The last form of aid is through tax credit certificates. You receive a mortgage certificate providing a tax credit. There are typically residency restrictions to achieve the full benefit.
Buying a home with less than 20% of the purchase price is made possible by assistance programs and government guarantees, allowing you to overcome the hurdle of a small down payment.
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