If you don't have 20 percent to put down on a new home, that doesn't mean you can't buy one. Does that surprise you? Then listen to this: there are all kinds of strategies for prospective home buyers who can't get the cash together for the traditional 20 percent down.
In fact, homebuyers could get a loan with as little as 3.5 percent down through the Federal Housing Administration, says Joe Parsons, senior loan officer with PFS Funding in Dublin, CA and author of "Growing Equity: A Guide for the Hopeful Investor."
If you're interested in hearing more, you're in the right place. Let's take a deeper look into ways you can get a mortgage with a low down payment.
Strategy #1 - Get Private Mortgage Insurance (PMI)
Wondering how you could avoid living with Mom and Dad until you've saved up that 20 percent down payment for a home? Private mortgage insurance (PMI), might be the answer you're looking for. PMI is basically an insurance premium you pay each month when you put down less than 20 percent on your mortgage.
"The cost of PMI will depend on the loan to value ratio (LTV) and on the borrower's credit score," Parsons says. The LTV is the ratio between the amount you want to borrow and your home's value. The larger that ratio is, and the worse your credit score is, the more you might have to pay for PMI.
That means that if you put 10 percent down and you have a credit score of 760, you could be paying $99 a month for PMI, Parsons says. But if you put down 3 percent and had a credit score of 760, you could be paying $279 for the same loan. Have a credit score of 700? That premium could jump to $330 a month, he says.
But there is some good news: "Sometimes these [insurance] premiums will disappear altogether once you hit the 20 percent equity mark on your home," says Howard Dvorkin, CPA, founder of ConsolidatedCredit.org, and author of "Power Up: Taking charge of your financial destiny."
That could happen if you pay down the principal on your loan to 80 percent, or if the value of your home goes up and you have 20 percent equity in your home as a result. Be sure to check with your lender on their policies surrounding eliminating private mortgage insurance.
Strategy #2 - Get a Federal Housing Administration (FHA) Loan
Since the Federal Housing Administration insures the loan - meaning they take on the risk associated with you possibly defaulting on the loan - you're generally allowed a lower down payment. That can be as low as 3.5 percent of the loan, Parsons says.
Plus, it's typically easier to qualify for an FHA loan than a conventional loan - meaning you can have a lower credit score, for example. Sound too good to be true? Well, an FHA loan does come with some drawbacks.
"The disadvantages are that the mortgage insurance is comparatively expensive and will be there for the life of the loan," Parsons says. That's in contrast to a conventional loan, where as we discussed, you could get rid of PMI after you have 20 percent equity in your home.
Now let's look at the cost. There are two components to the insurance on an FHA loan. The first is called Up Front Mortgage Insurance (or UFMIP). It equals 1.75 percent of the loan amount, and it's paid once, usually by adding it to the loan amount.
The second is the Monthly Mortgage Insurance Premium (or MIP), which is an annual premium paid monthly (like you'd pay for your car insurance, for example). MIP can vary from 1.30 to 1.35 percent depending on your loan-to-value ratio (your loan amount compared with the value of your home), paid monthly.
Strategy #3 - Get a "Piggyback Loan"
Have you ever heard of a "piggyback loan" when it comes to mortgage financing? This used to be very common, according to Parsons. It basically means a homeowner would get one loan for 80 percent of the value of the house, and then a line of credit on top of that up to the remaining 20 percent of the value of the house.
Because of this, many people got into homes without any down payment at all. But the problem is that not all of them could afford the monthly payments on those loans.
"There were huge losses in the wake of the meltdown, so banks are very reluctant to make these kinds of loans today," says Parsons. "Most lines of credit are capped at a total loan to value of 80 percent, so they will be of little or no help to a buyer with a small down payment."
That's not to say these loans no longer exist, and that there aren't exceptions. But before you go looking for one of these, you might want to speak with a mortgage professional who can examine your particular situation and talk through the pros and cons with you.
Dvorkin warns that while this strategy might get you into a home, the interest rate on a home equity line of credit is usually higher than that of a mortgage, and often increases throughout the course of the loan. "In the end, the final payment is considerably larger than the normal payments. So, while this is a viable solution, it can add up in the long run," he says.
Strategy #4 - First-Time Home Buyer Programs
If you're thinking about buying your first home, you're probably feeling both excited and nervous. And chances are you might not have saved up 20 percent to put down on that first home either. Well, here are some resources for first-time home buyers that could help make the process a little less frightening.
"Different states and communities have different programs to help first-time home buyers," says Parsons. One example he cites is the California Housing Finance Agency (CAlHFA), which has a number of programs for first-timers including the California Home Down Payment Assistance Program.
"With CHDAP, the buyer receives a loan of 3 percent of the purchase price. This loan can be used for a down payment or closing costs, and doesn't have to be repaid until the first mortgage is paid off through refinance or sale." It could benefit you to check into whether your state has a similar program.
"This could be right for anyone who is a first-time home buyer who doesn't have a large down payment," Parsons adds.