One of the questions we get asked frequently is “how much of a downpayment do I need to purchase a home”. This can also be one of the biggest barriers for many people. There are lots of misconceptions out there about down payments. One of them is that you need to put down 20% if you want to buy a home.
Now, before I go any further in this article, I want to say that it is a good idea to put down 20% or more if you can. There are a few reasons why. First – it gives you equity in your home from day one – and it lowers the amount you have to mortgage, which will save you thousands of dollars in interest over the life of the loan. Purchasing a home is an investment, and the more you can invest up-front the better.
Second, if you put less than 20% down, your mortgage company is going to add PMI (Private Mortgage Insurance) to your monthly payment. PMI is solely for the protection of the bank – it offers nothing for you. Until you have equity in the home, the bank needs to make sure they’re protected in the event you default on your loan. PMI can add hundreds of dollars to your monthly mortgage payment. Traditionally, PMI is anywhere from .5% to 1% of the total loan amount every year. If you borrow $250k for your home, that’s going to add anywhere from $100 to $200 per month to your mortgage payment until you have equity in the home. That could take years.
However, the fact is that not everyone can put 20% down on a home, and that shouldn’t necessarily be a barrier to entry. With a median price of $270k for homes in Florida, that would require a down payment in excess of $50k. It’s important to understand that not all lenders require a 20% down payment. There are a number of programs out there to help home buyers (especially first-time buyers) lower the down payment necessary to purchase a home.
One of the best programs out there are VA loans, but they are only extended to those who have actively served in the military. VA loans require no money down and very aggressive interest rates. However, not all homes are eligible for a VA loan (your real estate agent can tell you if a home is eligible for a VA loan). The VA has strict guidelines for its loans. You have to meet a minimum service requirement, you must be considered a ‘good credit risk’, and the VA has its own criteria for what homes will qualify.
FHA loans are loans that are guaranteed by the Department of Housing and Urban Development. These loans are available for first time home buyers and typically have lower credit score requirements and lower closing costs. They usually require a downpayment of around 3.5% (that’s not set in stone, but generally that’s the amount). There are limitations though.
The FHA sets a maximum price on the home you can purchase. The max price depends on the area you’re looking to live in. In Central Florida right now, that limit is in the low $300k range. However, because the government guarantees the loan, it makes it easier for those who don’t have the money for a 20% downpayment. It also is an option for those who have had credit issues in the past, to secure financing. It’s important to note that these loans are processed by lenders, not by the government. Some of the requirements for FHA loans include a debt to income ratio under 43%. The home you purchase must be your primary home, and you must have steady income and proof of employment. Also, FHA loans require mortgage insurance. If you have a credit score above 580, you’ll qualify for a lower downpayment than if your credit score is below 580.
There are many other programs out there – too many to list here. There are also resources that can help with downpayment assistance. If you’d like to research more information, the Downpayment Resource website can help you find potential matches.