How Much Is Needed for a Down Payment on a Home?

Nov 26, 2019
3 percent down

When you ask what percentage down payment you might expect to make on a home’s selling price, it’s not uncommon to hear a response of “ten to twenty percent.” Although this range was once considered the conventional benchmark for a 30-year fixed-rate mortgage, the majority of U.S. homebuyers today aren’t waiting to amass this amount before getting into the housing market. This is especially the case in certain highly competitive housing markets in California where the median 20 percent down payment equates to nearly two years’-worth of an average salary.

Motivated by the opportunity to build greater financial security through home equity and appreciation in value over time, homebuyers are taking advantage of a wide array of mortgage programs with lower down payments. If you’re aspiring to buy a home and avoid sizeable upfront costs, arm yourself with these facts about various options available in today’s market:

The conventional mortgage—but less money percent down: You may be eligible for a mortgage with a down payment as low as 3% of a home’s purchase price, if you can satisfy the lender’s specific qualifications and underwriting guidelines. For the sake of comparison, a down payment of 3% percent on a home with a selling price of $850,000 would be $25,500. If you were to put 20% down, you would have to come up with $170,000.

In assessing whether to approve a loan and at what interest rate, lenders will consider your credit score and history, income, debt levels (or more specifically, debt-to-income ratio), assets, liabilities, and work history. To protect their investment, they also take into account the value and condition of the home itself before making a final commitment.

While a smaller down payment generally means spending more money over the life of the home loan, it can also make all the difference when it comes to the accessibility of home ownership. A Zillow survey drives home this point by revealing that 67.9% of renters name the down payment as the number one obstacle to home ownership.

In most cases, your lender will require you to pay private mortgage insurance (PMI) if your down payment is less than 20 percent on a conventional loan. Paid in either a lump sum annual payment or added to your mortgage payment each month, it is intended to protect your lender in case you stop making payments and the home goes into foreclosure. Although rates vary according to credit scores and other factors, PMI generally costs homebuyers anywhere from .30 percent to 1.00 percent of the loan amount on an annual basis. Freddie Mac reports that PMI averages $30 to $70 per month for each $100,000 borrowed. You can request that your PMI be dropped once your mortgage balance is paid down to 80 percent of the home’s original appraised value. Legally, your mortgage servicer must eliminate your PMI when this loan-to-value ratio drops to 78 percent.

The FHA loan: If you don’t have a solid credit history or you have a lower credit score, a loan backed by the U.S. Federal Housing Administration could be a good option for you. This type of loan allows for a minimum 3.5% down payment for a 30-year fixed-rate mortgage and it is easier to obtain than a conventional loan. Although the FHA loan doesn’t have a minimum income requirement, you will be expected to demonstrate that you can reasonably afford to make your mortgage payments.

One drawback to an FHA loan is that you’ll need to pay an upfront mortgage insurance premium of 1.75% of the loan amount (this can be financed), in addition to a monthly mortgage insurance premium that is added to your mortgage payment. In contrast to conventional loans, you pay mortgage insurance on FHA loans regardless of the amount of your down payment. In a May 2019 article, U.S. News & World Report estimated average monthly insurance premiums at $70 for every $100,000 borrowed. You’ll pay your FHA mortgage insurance premiums for the life of the loan— if you made a down payment of less than 10 percent. However, you can potentially eliminate these payments by refinancing with a loan that is not backed by the FHA. With a down payment of 10 percent or more, you’ll pay mortgage insurance premiums for 11 years (if you don’t refinance).

The VA Loan: For those who are U.S. military veterans, active-duty military personnel, or an eligible surviving spouse, the U.S. Department of Veterans Affairs offers an excellent loan program that provides up to 100 percent financing as well as low interest rates. Not only can you get a home loan with no down payment, you won’t have to pay monthly mortgage insurance premiums or private mortgage insurance. However, you will need to qualify in terms of income and credit, and pay a basic, upfront funding fee ranging from 2.15% to 2.40%.

The USDA loan: Backed by the U.S. Department of Agriculture, this is another zero-down loan that offers very low interest rates, as well as low fees. However, it only applies to properties in specific rural areas and outlying suburban areas. The program also has quite stringent requirements related to income limitations and income-to-payment ratios.

The Advantages of 20 Percent Down:

If you’re on a steady course toward assembling the funds for a traditional 20% down payment, there are valid reasons to forge ahead toward this goal. Not only can you reduce your monthly payments, you’ll save money in interest with a smaller mortgage. You may also qualify for a more favorable interest rate because lenders view larger down payments as a sign of financial strength and reliability. From the lender’s perspective, you’re less likely to default since more of your own money is at stake. In addition, a 20 percent or higher down payment allows you to avoid paying mortgage insurance. Moreover, a larger down payment will enable you to build equity in your home faster, and provides a degree of financial protection in a down market. If your home drops in value, you’re less likely to find yourself underwater, or owing more money on the loan than your home is worth.

Approach Zero-Down Payment Loans with Caution:

As you’re considering the various options for financing your home, you may be tempted to consider a zero-down payment loan that provides 100 percent financing. In the years leading up to the 2008 financial crises, these types of loans were a popular way to get people into homes. However, zero-down payment loans came with inflated interest rates and high fees to compensate lenders for their risk. If you are considering a loan of this type, you may want to reconsider. If your home value falls — such as it did for many borrowers during the financial crisis — you could find that you owe more on your mortgage than your property is worth, which could put you in financial peril. When it comes to zero-down payment loans, borrowers should proceed with extreme caution, perhaps keeping in mind the millions of homeowners who ended up defaulting on their loans during the recession.

Buying a new home is not only a rewarding life-achievement, it can help build wealth and future financial stability. The various financing options that are available today can definitely help make it more affordable to get into a home. However, every buyer should undertake this decision with a clear understanding of how to weigh the costs and benefits according to their unique situation. For help, a great place to start is our online Financial Calculators, but it is also beneficial to talk to a mortgage broker and/or financial planning advisor, who can guide you toward the right decision for you.

When you’re ready to buy, The Police Credit Union has a wide variety of competitive mortgage options to fit your budget and lifestyle goals. And now for the first time, we are offering a Low Down Payment Mortgage with rates as low as 3% for qualified buyers! Terms and conditions apply--find complete details here.




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