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Homeownership is a dream that many people share — but saving for a down payment can be difficult, especially in an era of high inflation. However, even if you can’t make the traditional 20% down payment, it doesn’t mean you need to put your dream of owning a home on the back burner. Is there such a thing as a lower down payment…like, a zero down payment?
A zero-down-payment mortgage is a home loan that you can get without putting any money down — but only for specific loan types, and not every buyer and home will qualify.
“You can walk in without [taking] any money out of your pocket,” says Richard Helali, mortgage sales leader at HomeLight Home Loans (though note that you may be responsible for some closing costs, depending on your situation). After speaking with the experts, we’ll walk you through your options and what you can expect from zero-down-payment mortgages and low-down-payment programs. Financing a home may be more feasible than you think!
The 20% down myth
The 20% down rule is a myth — the 20% number is really just a benchmark.
“Some people have the misconception that a 20% down payment is required for a home purchase when, in reality, many home loan options exist that may be able to put consumers into a home for a smaller down payment,” says Mike Cornelius, loan originator for nine years and branch manager at Motto Mortgage Experience in California. “It really depends on timing and the financial situation of the consumer.”
According to a 2020 research report from the National Association of Realtors, the average down payment on a house or condo was 12%. For first-time buyers, this number was only 7%.
“Often, repeat buyers are able to put 20% down or more, typically because they are moving the equity gained in their existing home they are selling to the new home they are buying,” explains Cornelius.
There are loan programs that allow you to put down much less than that — as little as 3% or even no down payment! However, your down payment is also tied to the terms of your loan — the less you put down, the less favorable terms you’ll get, and the more you’ll pay for your loan both upfront and over time.
Your down payment gives your mortgage lender a sense of security. “Regardless of somebody’s credit score, if they buy a house and put less than 20% down, they’ll be more likely to foreclose versus someone who put at least 20% down,” says Helali. “It’s kind of like a ‘skin-in-the-game’ type of thing.”
Pros of putting no money down
The obvious advantage of a zero-down mortgage is leaving that extra cash in the bank and not having to worry about a down payment. But there’s more to it than that.
A zero-down mortgage means you aren’t struggling to save money to make a big down payment. Instead, you can buy a home and use cash reserves to start building equity sooner.
You can also put that money toward investments instead of funneling everything toward your down payment. By investing your money, there’s potential to build some long-term returns.
Zero-down mortgages can also give you the opportunity to time the market and take advantage of low interest rates while they’re available. A low interest rate means you’ll pay less interest on your principal over the life of the loan.
Cons of putting no money down
There are drawbacks to borrowing the full purchase amount, all that said. Because you’re taking out a bigger mortgage loan, you’ll be making larger monthly payments. The lender is also taking on more risk, and you may have to pay a higher interest rate to make it worth their while. You’ll also likely be required to pay mortgage insurance to cover the lender’s risk.
Your lender may also require a higher credit score for these loans, and zero-down loans aren’t widely available. Only certain qualified buyers may have the option for a zero-down-payment loan.
Putting no money down also means you’re starting with no home equity, meaning it will take longer to build wealth. Home equity is another way of talking about how much of your house you own; it’s calculated by subtracting what you still owe on your mortgage from the appraised value of the home. If you owe $100,000 on a home appraised at $250,000, then you have $150,000 in equity — which can be a useful tool! Your equity will increase as you pay off your mortgage and the value of your home increases.
Additionally, real estate prices depend heavily on the current market. What if there’s a downturn affecting the value of your home, and you’ve found yourself in financial trouble? This could result in negative equity, which means that you’re “underwater” on your loan — you owe more on the mortgage than the house is worth.
“You might be a little stuck. If you sell your home, you’re going to have to come out of pocket with some funds,” explains Helali. “It’s going to be very difficult or almost impossible nowadays to refinance if you owe more than what the place is worth.”
Zero-down payment mortgage options
Only government-backed loans offer zero-down options to homebuyers; for conventional loans, you’ll need to put something down. Having the government backing the loan means lenders are taking on less risk compared with a conventional loan. Because of this, private lenders are more comfortable extending zero-down financing on government-backed loans with favorable rates and terms.
Here are two zero down payment options for qualifying buyers.
1. USDA loan
A U.S. Department of Agriculture loan is a zero-down mortgage option for qualifying homebuyers and homes. USDA loans can only be used to buy homes in designated locations, which typically cover rural and some suburban areas.
Most of these loans aren’t directly offered through the USDA. They’re government-backed loans offered by traditional lenders, such as banks and credit unions.
These loan programs help thousands of Americans each year buy a house with low interest rates, a credit score as low as 640, and zero down payment. Payments on USDA loans are generally restricted to 29% or less of your monthly income, and monthly payments can’t exceed 41% of your monthly income.
The USDA offers two types of home loans for buyers: the Single Family Housing Guaranteed Loan Program and Single-Family Housing Direct Home Loans. According to the USDA Rural Development’s yearly totals for 2020, the USDA issued 5,825 Direct Home Loans totaling over $1 billion and 137,970 loans through the Guaranteed Loan program totaling over $23 billion.
The Guaranteed USDA Loan is typically for low- or moderate-income borrowers, while Direct Home Loans favor low-income and very-low-income Americans who can’t access any other type of financing for a safe and sanitary residence.
Here’s what you need to qualify for these loan programs:
- A credit score of at least 640 (the USDA program technically does not have a minimum credit score, but most lenders will require a minimum credit score of 620-640)
- Combined household income can’t exceed more than 115% of the median family income in the designated rural area where you want to buy
- Must occupy the house as your primary residence
- Must have U.S. citizenship or be a legal permanent resident
- A minimum of 12 months of no late payments or collections on credit accounts
These numbers don’t include closing costs, which include lender and administrative fees, and vary by location. Closing costs usually equal between 2% and 5% of the loan amount. However, because paying the closing costs may not be feasible for everyone, borrowers can often roll closing costs into their mortgage balance or use USDA loan gift funds for either a down payment or closing costs — so long as the funds can be verified and the buyer still meets other loan program and lender requirements.
Here are some of the great benefits to USDA loans:
- Zero down payment
- Low fixed interest rates
- Sellers can pay closing costs
- Ability to finance repairs and closing costs into the loan
- No prepayment penalty, meaning you can pay off your loan early and not be penalized
- Flexible guidelines (you can even build a home!)
However, there are disadvantages:
- Geographical restrictions
- Strict income limits
- Because USDA loans require little to no down payment, you can expect to pay an upfront insurance premium, between 1% and 2% of the loan amount.
- Borrowers are expected to pay a fee of about 0.35% to 0.40% of the loan amount throughout the year
2. VA loan
VA loans are backed by the U.S. Department of Veteran Affairs; since its establishment in 1944, the VA has backed more than 25 million home loans for U.S. veterans and military members. In 2020 alone, the VA guaranteed a record loan volume of more than 1.2 million home loans, totaling more than $363 billion. This equates to 3,200 loans per day, the most in the history of the program. Similar to USDA loans, VA loans are offered by most (but not all) traditional lenders.
The VA loan program offers several options, including purchase and refinance mortgages, rehab and renovation loans, and the Native American Direct Loan.
Here are the eligibility requirements for a VA home loan:
- You served 90 consecutive days of active service during wartime, or
- You served 181 days of active service during peacetime, or
- You have 6 years of service in the National Guard or Reserves, or
- You are the spouse of a service member who has died in the line of duty or as a result of a service-related disability
VA loans offer borrowers plenty of benefits:
- Zero down payment
- There’s no official minimum credit score requirement, but the lenders who extend these loans often require minimum scores of 640
- The VA allows a debt-to-income ratio of 41% or less (some lenders might allow up to 50%!)
- No prepayment penalty
- No mortgage insurance
Here are a few VA loan drawbacks:
- Borrowers are required to pay a funding fee at closing, ranging from between 1.4% and 3.6% of the loan’s total value.
- Sellers may not want to deal with VA loans. Many sellers believe — rightly or not — that VA loans come with more red tape than conventional loans.
- The lender may have additional underwriting requirements.
- Appraisal requirements are strict. The home must meet minimum safety, sanitation, and structural integrity standards.
Low down payment home loans
While you do need to put something down for conventional mortgage loans, it doesn’t have to be 20% — or anything near that amount.
“There may be options out there for almost every type of [qualified] homebuyer, but buyers should prepare and do their research with their mortgage professional,” states Cornelius.
“ Loan options available can also vary widely by state and based on the financial situation of the consumer.”
We’ll break down the need-to-know on conventional loans and low-down-payment home loan options.
A conventional mortgage loan is a private home loan that is not guaranteed by the federal government but is usually offered by the same lenders. These loans are known as “conforming” because they are backed by Fannie Mae and Freddie Mac and meet the Federal Housing Finance Agency (FHFA) loan limits — $548,250 or $822,375 in select high-cost areas.
Fannie Mae and Freddie Mac are government-sponsored enterprises that purchase mortgage loans from lenders and sell them to investors. While there are nonconforming loans, they can cost more than conforming loans, and they don’t meet Fannie or Freddie’s guidelines. One example is a jumbo loan, a loan that exceeds the FHFA loan limits.
There’s no single list of requirements, but many borrowers with a solid credit score, reliable income, and money saved for a down payment will satisfy the requirements for a conventional mortgage loan. Here are general requirements for a conventional loan:
- A minimum credit score of at least 620, preferably higher
- A DTI ratio lower than 45% (including the mortgage payment)
- A down payment of at least 3%
The minimum down payment depends on your situation and the type of property or loan:
- 3%: If you’re a first-time homebuyer, it’s possible to get a conventional loan with a down payment as low as 3%
- 5%: If you’re not a first-time buyer
- 10%: If you’re buying a second home or getting a jumbo loan
- 15%: If you’re buying a multi-family home
First-time homebuyer doesn’t mean that it has to be the first home you’ve ever owned. “A first-time homebuyer is defined as somebody who has not had an ownership interest in a home in the previous three years,” says Helali. If it’s been 10 years since you’ve owned a home, then by definition, you are a first-time homebuyer.
Conventional mortgage loans require no upfront mortgage insurance fee like VA and USDA loans, even if you put less than 20% down. You are expected to pay closing costs — between 2% and 5% of the loan amount, depending on the lender. That means if you take out a $250,000 mortgage, closing costs can range from between $500 and $12,500.
While you do need to put cash down with a conventional mortgage, there are some advantages:
- Conventional loans can typically be obtained more quickly than a government-backed loan
- Conventional loans come with more options as far as loan terms
- Some fees can be negotiated
- Because you have to make a down payment, you’re starting with equity
But, there are disadvantages:
- Higher down payment requirements
- Stricter credit score requirements
- Interest rates can be higher than USDA or VA loans
- PMI required if you’re making a down payment of less than 20%
What about private mortgage insurance?
Private mortgage insurance, or PMI, is a type of mortgage insurance you may have to pay on a conventional loan if you purchase a home with less than 20% down.
PMI protects the lender if you ever stop making mortgage payments. If you go into foreclosure and your home is sold at auction, the lender may not make enough to cover the remaining balance. Costs vary, but PMI typically costs between 0.5% and 1% of the entire loan amount annually.
Once you have PMI, you can get rid of it in two ways:
- Request PMI termination: Request your lender to cancel PMI when you’ve reached 20% equity.
- Automatic PMI cancellation: PMI will automatically be terminated on the date where you reach 78% equity based on the original sale value of your home
PMI is not the end of the world, and it gets eligible borrowers into homes much faster. Once your mortgage balance is paid down, PMI will be canceled.
Conventional low down payment programs
Conventional mortgage loans offer flexibility, with low down payment programs for qualifying borrowers.
Home Possible from Freddie Mac (as little as 3% down)
The Freddie Mac Home Possible mortgage is available to either very-low-income or low-income borrowers with a down payment as low as 3% and a credit score as low as 660. However, household income must not exceed 100% of the average area median income.
HomeReady by Fannie Mae (as little as 3% down)
Fannie Mae’s HomeReady program was designed to help creditworthy first-time or repeat homebuyers living on lower incomes.
Borrowers with a credit score of 620 or higher (680 and higher may get better pricing) and within the income limit of 80% of the area median income for the property’s location may be eligible. If all borrowers are first-time buyers, one borrower is required to take homeownership education classes.
Conventional 97 (3% down)
As the name implies, the Conventional 97 program, or the 97 loan-to-value purchase program, allows homebuyers to have an LTV ratio of 97%. Borrowers can purchase a home, condo, co-op or a planned unit development with just 3% down, which can also be gifted.
Most borrowers are eligible; however, you must be a first-time homebuyer (you haven’t owned a home in the past three years). The minimum credit score for a Conventional 97 is 620, PMI cancellation is the same as with a conventional loan, and there are no income limits.
Good Neighbor Next Door (as little as $100 down)
The Good Neighbor Next Door program is sponsored by the U.S. Department of Urban and Housing Development and insured by the Federal Housing Administration, and it was designed to improve the quality of life in “revitalization areas.”
Eligible borrowers must be full-time law enforcement officers, pre-kindergarten through 12th-grade teachers, firefighters, or emergency medical technicians to receive a 50% discount off the purchase price of the property and put down a minimum of just $100.
Borrowers must have a credit score above 580 for 100% financing, and borrowers with credit scores between 500 and 579 can receive 90% financing.
FHA loans are backed by the Federal Housing Administration and issued by FHA-approved lenders. These loans are designed for low-to-moderate-income borrowers who may not have the minimum credit score required for a conventional loan.
Here are the requirements for FHA loan eligibility:
- A minimum credit score as low as 500 if you make a 10% down payment. If your credit score is 580 or higher, your down payment can be as low as 3.5%.
- Your DTI should not exceed 43%, but some lenders may allow up to 57%.
- The home must be the borrower’s primary residence.
- The borrower must have a steady income and proof of employment.
FHA loans require borrowers to pay two types of mortgage insurance premiums. An upfront mortgage insurance premium, which is 1.75% of the loan, must be paid at closing. Additionally, buyers must pay an annual MIP, which is between 0.45% to 1.05% of the loan. MIP is either 11 years or the life of the loan, depending on the LTV and the length of the loan.
Some benefits of FHA loans include:
- Lower credit score requirements
- Low down payment
- Down payment may come entirely from gift funds or down payment assistance
- Upfront MIP can be included in the loan amount
- No income limits
A few disadvantages of FHA loans are:
- Higher total MIP costs
- Strict housing standards. All homes purchased with FHA-backed loans must meet minimum health and safety standards. You may have a hard time getting a lender to approve a fixer-upper, though a FHA 203(k) rehab loan may be an option.
- FHA limits are 65% of an area’s conforming loan limits
- If you make the minimum down payment, you may have to pay mortgage insurance for the life of the loan.
“The nice thing about FHA is that it’s not restricted to first-time homebuyers. It can be your second, third, fourth, fifth or hundredth time — you can obtain an FHA loan, and you can put 3.5% down,” states Helali.
Down payment assistance
If you don’t qualify for a zero down payment or don’t have a ton in savings, help may still be available through down payment assistance. These programs reduce the amount needed for a down payment and help borrowers get into homes much faster with grants or low-interest loans.
Down payment assistance programs are available nationwide and vary by location. Qualifying homebuyers could save thousands of dollars if they find the right program.
A RealtyTrac report found that eligible homebuyers saved an average of $17,776 using down payment assistance programs. That breaks down to an average savings of $5,965 on the down payment, and an average savings of $11,801 on monthly payments over the lifetime of the loan. The report also found that in a majority of counties, these programs covered an average of 3% of the home purchase.
Helali advises that if you’re offered down payment assistance, specifically ask about the terms of repayment (if there are any) and what is required to qualify. “A lot of these programs are going to be different, so it’s always good to ask what repayment terms look like, if any,” he says.
If you’re curious about down payment assistance programs, the best place to start would be to look for programs specific to your area. Check assistance programs offered by your state’s housing finance agency or local homebuying programs.
Saving for a down payment is no easy task — but there’s help available to make homeownership attainable.
Header Image Source: (Kari Shea / Unsplash)