Five tips for buying a home with less than 20 percent down

Five tips for buying a home with less than 20 percent down
Sarita Harbour

Do you want to take advantage of today's low mortgage rates before they shoot up? If a low down payment is what's stopping you from taking action, you may be in for a surprise.

The truth is, you don't need 20 percent down to get a mortgage. Through various government, bank, and other programs, many homebuyers are able to pursue their homeownership dreams despite a low down payment. Even some of the most popular banks have been participating for decades.

"Wells Fargo and Bank of America have been offering low down payment loans through Fannie Mae and Freddie Mac since the programs first rolled out in the 1990s," says Greg Cook, who runs the First Time Home Buyers Network website.

And while these programs have been around for a while, they may not be on every potential homebuyer's radar, as conventional wisdom goes against having a low down payment. So how does a low down payment affect a borrower's chance of getting a mortgage? Cook says that the down payment amount is just one aspect of the total mortgage application.

"Whether a down payment is too low has to be taken in context with the other parts of the home buyer profile," says Cook. He says income ratios and credit scores are also critical components of the mortgage application.

Keep reading to learn what you can do to get a mortgage without 20 percent down.

Tip #1: Negotiate With Your Banker/Underwriter

If you're looking to secure a mortgage with less than 20 percent down, the first thing you should do is have a conversation with your banker. This is what Garry Polmateer, an entrepreneur from Albany, New York, did.

For Polmateer, buying a home while getting a company up and running meant money was tight for a down payment.

"When I bought the house it was my first year of being in business, so it wasn't a terribly profitable year," he says. In the hopes of reducing the required 20 percent down payment for his new home, Polmateer focused his attention on dealing directly with his bank.

"I managed it by working with a small bank that writes their own loans, and I was persistent and negotiated with them." Polmateer says that before requesting the down payment reduction, he had to address the lender's concerns about the unpredictability of his business income.

"I explained the industry that we are in and discussed growth of our main partner company, our sales pipeline, as well as general trends," Polmateer says. He says he wore business attire to the meeting and provided information on the financial health of his business. He also provided client references to show that his business (and his income) was solid and growing

Polmateer's strategy paid off.

"I focused all of my energy on helping them feel comfortable lending me money, and then I ended with my ask," he says. At that point, Polmateer requested the down payment requirement be reduced to just 15 percent. "That made the difference in me and my wife being able to move into the house or having to pass up our dream home - a little log cabin in a small upstate New York town," he says.

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Tip #2: Opt for an FHA loan

If you're a first time homebuyer who just can't get a 20 percent down payment together, a loan through the Federal Housing Administration (or FHA) may be the answer, says Grace Keister of Irvine California's First Team Real Estate.

"FHA loans are great because you are able to secure them with less-than-perfect credit and looser underwriting guidelines," says Keister. "[They] are the most popular and easiest way for first-time homebuyers to get help securing a low down payment."

This type of loan is available to first time homebuyers with a down payment as low as 3.5 percent, she explains. Additionally, your closing costs can be rolled into this type of loan, so you don't have to worry about the upfront cash costs. The one caveat is that your loan and closing costs can't exceed 96.5 percent of the home's fair market value.

And while this is a great option for borrowers who can't put down a large down payment, there is one cost that comes with this loan: Private mortgage insurance (PMI). PMI is meant to protect lenders against loss if a borrower defaults on a loan. Most lenders require PMI until the borrower has paid at least 20 percent of the loan's principal, but some FHA loans require PMI for the life of the loan, so make sure to talk to your lender about the exact terms of the mortgage.

To qualify for this loan, a borrower must be able to put down at least 3.5 percent, since the loan covers 96.5 percent, according to the U.S. Department of Housing and Urban Development. And eligible properties are one-to-four unit structures. Beyond that, you can have less-than-perfect credit, but may be deemed ineligible in the following cases, according to HUD:

  • You have delinquent federal debt.

  • You have suffered a foreclosure in the previous three years.

  • You have declared bankruptcy in the past two years.

  • You have made late mortgage payments in the past 12 months.

  • Your credit report reveals that you are disputing any credit accounts or public records.

For more details, please contact an FHA lender.

Tip #3: Look to state and municipal programs

If you can't swing a 20 percent down payment, our experts say to look to your local and state programs for help to buy a home.

"Anything where down payment help is provided is going to be based upon municipality/county income limits," says Dan Gjeldum, senior vice president of mortgage lending at mortgage company, Guaranteed Rate. "As a homebuyer, I would research your community and county to determine what is available to you locally."

Some of these programs may even offer reduced or no down payment loans and assistance, says Hillary Legrain Esq., assistant vice president of First Savings Mortgage Corporation. Legrain says one such program, the DC Open Doors program in Washington D.C., has two options for home buyers.

[Click to compare loan options and interest rates from multiple lenders now.]

"It allows for either a 3 percent down payment, or if you take a higher rate you can receive a 3 percent grant that is forgiven in full over a period of five years." Legrain says this has the effect of 100 percent financing.

Here's how it works. The loan doesn't need to be repaid unless the borrower sells, refinances, or no longer occupies the property, according to DC Open Doors. Otherwise, the loan functions more as a grant that is forgiven over a period of five years, with 20 percent of the grant amount forgiven each year, says Legrain.

"If the borrower takes the 3 percent grant they are able to purchase the home without any down payment required," says Legrain, adding that the income cap on this program for one borrower is $123,395.

Tip #4: Lower your debt-to-income ratio

In order to get away with a low down payment, it helps to be financially fit. One major indicator of this is a strong debt-to-income (DTI) ratio, says Gjeldum.

According to the Consumer Financial Protection Bureau (CFPB), the DTI ratio is one way lenders measure your ability to make monthly payments on money you've borrowed. It's calculated by adding up monthly debt payments and dividing them by gross monthly income (before taxes and deductions), says the CFPB site.

Generally, the down payment amount isn't more important than a borrower's DTI, according to Joe Fairless, a real estate investor and mentor in New York City.

"The down payment is merely a means to acquire the house," explains Fairless. "The real issue is if the buyer can afford the monthly payments, so really it's a matter of the right debt-to-income ratio to ensure the borrower can afford the payments."

So what's the right number? A DTI that's 43 percent or less is ideal, because studies show that borrowers with a higher DTI have difficulty meeting their debt payments, according to CFPB. So if you have a low down payment, you should strive to have a DTI under 43 percent. That number is also based on Qualified Mortgage (QM) guidelines, which ensure that you're more likely to make your payments, says the CFPB site.

If your DTI is higher than 43 percent, there are two ways to reduce it. First, you can increase your income, which could mean working overtime, asking for a salary raise, or working an additional side gig. But if that doesn't seem feasible, your second option is to pay off your debt, which could make your DTI drop dramatically.

[Shopping for a home loan? Click to compare interest rates from multiple lenders now.]

Tip #5: Increase your credit score

If you want to land a mortgage with a low down payment, your credit score could help in your eligibility for certain loans, because it tells lenders the likelihood that you will repay your debts. For example, an FHA loan generally requires a FICO score of at least 580 to qualify for maximum financing with a low down payment of 3.5 percent.

But what if your credit score isn't so great?

"If you have anything less than ideal on your credit history, a true mortgage professional will be able to help counsel you on ways to improve scoring, how to get things permanently removed, etc.," Gjeldum says. They can also help you spot errors.

 "Spending a week or two fixing errors on your report can save you thousands of dollars over the life of your loan," says Gjeldum. The lower your credit score, the more costly everything becomes - including the rate, fees, and mortgage insurance premiums.

Nathan Fisher, a lighting analytics specialist with Technical Consumer Products of Cleveland, Ohio credits his strong credit score with helping him get a low down payment mortgage. The 24-year-old had a credit score of 750 and was approved for a government-backed FHA loan. According to HUD's website, borrowers with credit scores below 499 are not eligible for FHA loans. Additionally, a borrower needs to have a credit score of at least 580 in order to qualify for financing with a 3.5 percent down payment or less.

"I worked with Howard Hanna [Real Estate] as a one stop shop for mortgage, realtor, and title," he explains. "An in-house team was able to determine, based on my credit score, liabilities, and income, how much I could afford and if I was approved."

Thanks to high credit, he was able to put down 3.5 percent and buy a decent duplex, he explains. The program Fisher is in requires mortgage insurance (PMI) for at least five years. He says that with rates so low, it's still economically viable in his situation. However, it might not suit everyone.

 "I would not recommend this method to an established family," he says. His PMI is 9 percent of the mortgage payment, and he says the PMI payment can be a major drag on finances.

"But as a younger worker, it can be a powerful way to gain equity."