No, you don’t need 20 percent down or even close to it

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Today, large down payments are nothing more than suggestions. In fact, there are many reasons to opt for a smaller down payment:

• You can conserve cash and invest it.
• Pay off other debt, such as credit cards or student loans.
• Tackle repairs in your new home.
• Set aside an emergency fund for unforeseen home repairs or other expenses.

New options challenge down payment conventions

Decades ago, conventional wisdom said potential home buyers should make a down payment of 20 percent.

Doing so, the logic went, would help them secure a good interest rate and make monthly mortgage payments less costly.

Lower payments would help home buyers afford the expenses of home ownership — from closing costs to homeowner’s insurance to emergency funds.

But 20 percent down proved too large a hurdle for many potential homeowners as housing prices rose in the 1990s and beyond.

Today, large down payments are nothing more than suggestions.

Down payment options from zero to fifteen percent are transforming the way people buy homes, especially first-time home buyers.

Regardless of financial status, age, background, or nationality, home buyers are learning how to make a down payment that suits their needs. They are no longer worried about adhering to outdated ideas about a “normal” down payment.

History of low-down-payment options

FHA loans have been the go-to low down payment option for decades, but newer products are entering the market, such as Fannie Mae’s HomeReady^TM, which requires just 3% down.

Older mainstays such as the VA home loan and USDA mortgage require nothing down whatsoever.

These and other products have gained popularity, especially since the 2000s when U.S. government heads foresaw an ownership society in which quality of life would improve as more people owned homes.

Even traditionally conservative agencies like Fannie Mae and Freddie Mac issued zero-down loans.

More Americans bought into the dream; home prices continued to climb.

Private companies upped the ante, issuing Alt-A mortgages and high-dollar loan amounts to applicants with low credit and, often, no income verification.

Since then, evidence has shown that down payment — or lack thereof — has little or nothing to do with loan repayment.

It was not low-down-payment programs from government agencies like HUD and VA that brought on the Great Recession. They never got into the no-doc game. Rather, it was private companies that forgot the basis of sustainable lending: the ability to repay the loan.

Since then, evidence has shown that down payment — or lack thereof — has little or nothing to do with loan repayment.

Armed with this knowledge, agencies have reintroduced safe, low-down-payment loan options. The conventional wisdom regarding the smartest, safest amount for a down payment has shifted again, especially for first-time buyers.

Few need to put down as much as 20 percent — unless they have the cash readily available from investments, a prior home sale, or an inheritance.

Instead, most lenders will accept as little as 3 percent, assuming they underwrite loans based on Fannie Mae and Freddie Mac standards. Lenders who are approved to underwrite loans to Federal Housing Administration (FHA) standards will need only 3.5 percent to issue you a home loan.

With all these options, how can a home buyer be sure they are putting down the right amount for their situation?

Making your “best” down payment

There’s no single magic bullet, but several choices can lead you to a comfortable financial fit. Here’s what to consider:

Start by doing your financial homework. Many free resources provide a sound overview to become financially savvy, including “360 Degrees of Financial Literacy,” a CPA-sponsored online financial guide recommended by David Almonte, a CPA and member of the AICPA’s National Financial Literacy Commission.

Next, meet with a mortgage professional and discuss what loans are available based on your latest credit score and income history. The goal is to come up with a percentage that will keep your monthly payment, plus real estate taxes, and escrow within your budget.

If you don’t have a budget — and you’re not alone — consider this good rule of thumb: keep your future mortgage payment within a reasonable percentage of what you’re paying in monthly rent.

Consider this good rule of thumb: keep your future mortgage payment within a reasonable percentage of what you’re paying in monthly rent.

For example, if you pay $1,500 in rent, you may choose to keep your future total house payment below 150% of that amount.

The percentage could be much higher or much lower depending on your current rent, room in your budget, and how much “fat” you can cut out of your monthly spending.

Another rule of thumb is to keep your housing costs under 28 percent of your monthly gross income — what you earn before taxes. Housing costs include the mortgage payment, real estate taxes, homeowner’s insurance, and homeowner association dues, if any.

Go beyond housing cost and look at all your other payments too. Most lenders cap your approved mortgage payment plus all other monthly debt payments to 43 percent of your gross income. This would include your monthly mortgage payments, other housing expenses, and all outstanding debt for revolving credit card and college loans.

When it comes to gross income, many lenders say it’s acceptable today to factor in a second income if you’re part of a dual-career couple. The HomeReady™ program even considers income from household members who are not on the loan.

Use all the income that is available to you when applying for a mortgage.

Advantages of a higher down payment

You avoid paying for mortgage insurance when you make at least a 20% down payment on a conventional loan.

With FHA, you pay mortgage insurance at any down payment level. But you pay it for a shorter amount of time with a large down payment. FHA loan amounts under $ require the borrower to pay mortgage insurance for the following duration.

• 11 years for a down payment greater than 10%
• Full term of the loan for a down payment less than 10%

That doesn’t necessarily mean you will pay insurance this long. You can refinance out of FHA to cancel mortgage insurance.

Like FHA, every loan type gives you down payment options with advantages no matter which amount you choose.

If you can’t put down 20 percent, ten to 15 percent down can be a good alternative.

Many lenders offer credit-worthy clients an equity loan or line of credit to cover a portion of their down payment.

Home buyers can take out an 80% first mortgage, a ten to 15% second mortgage, and make a down payment for the rest. This structure eliminates the need for mortgage insurance.

This mortgage strategy is called a first and second mortgage combo, 80-10-10 loan, 80-15-5, or piggyback mortgage.

The second mortgage payment is often lower than that of private or FHA mortgage insurance premiums.

Why choose a small down payment if you can afford a large one?

There are equally good reasons for you to make a much smaller down payment. By doing so, you retain available cash in the bank for emergencies, expenses, and other financial goals.

Conserve cash. “Cash is king, and you can use the extra income to invest,” says Mat Ishbia, President and CEO of United Wholesale Mortgage in Troy, Mich.

Pay off debt. Many lenders advise using available cash first to pay off credit card debt. That debt is calculated at a higher interest rate than a mortgage and doesn’t offer the same tax deduction.

With debt paid off or lowered, you’re also likely to see your credit score climb. You need a minimum of between 640 and 680 to secure the most reasonable loan rates. Improve your score and hit 740, and you’ll secure an even better rate.

Tackle repairs. Having cash on hand will allow you to make essential repairs and upgrades. Few homes are so perfect that you move in without wanting to do some work.

Emergency set-aside. Emergency funds are important to cover unforeseen home repairs or other non-home related issues. If your car breaks down or furnace goes out, it’s better to have cash on hand rather than finance repairs with a credit card. That can lead to higher expenses later.

How do I qualify for a low-down-payment loan?

Low-down-payment loans come with low mortgage rates, contrary to popular belief. In fact, some low- and no-down-payment loans come with lower rates than twenty-percent down conventional programs.

Low rates are widely available. Get a quote for your mortgage application. All quotes come with a home buying eligibility check, and your live credit scores. Only basic information is required to start the process.