Buying a home is both a huge life milestone and a huge investment. Many people spend years saving up for their first home but with market prices only increasing, their dream of owning a home can seem too far out of reach.
Traditionally you needed to provide a 20% down payment on a home. What was once a fairly affordable way to buy a home has now become a burden for many people. Due to inflation and other factors, saving up 20% of a home’s selling price for a down payment simply isn’t possible.
These days, there are numerous different types of loans available with different down payment requirements. Some are more affordable than others, but it depends entirely on your personal preferences and income. If you’re looking to buy a home with a low down payment. though, here are some tips and insider advice to help you out.
What You Should Know First
What is a Down Payment?
Before you look into buying a house with a low down payment, you need to know what that means and what it will look like. If you don’t, then you may find yourself confused or searching for the wrong thing.
A down payment is paid as soon as you sign the final closing papers. Traditionally, it’s 20% of the total loan, though some lenders offer low-down-payment options depending on your eligibility and financial situation.
Down payments are almost always required for mortgages. It’s a way for lenders to reduce the risks associated with lending money to borrowers, which means that the lower your down payment is, the higher your interest or other costs might be. This depends on the lender and loan type, though, so you always want to double-check.
Some People Are Eligible for No Down Payment Loans
As mentioned briefly above, some people are eligible for loans with no down payment. If you or your spouse is an active-duty military or National Guard member or a veteran, you may qualify for a VA loan. If you’re looking for a home or property in certain rural and suburban areas, then you may qualify for a USDA loan (no, you do not have to be a farmer to qualify).
4 Tips to Buy Home With Low Down Payment
#1. See if Your Loan Allows Others to Gift You the Down Payment Money
Some lenders will allow you to use gifted funds from family or friends to pay for your down payment, even if it’s low. Since not all loan types or lenders permit this, though, you should always ask before assuming you can use gifted money.
If you have family or friends that are willing and able to help you pay for your down payment, this can be a great way to buy a home without worrying about providing a large sum of money upfront. It is worth noting that with certain loans, you’ll have to increase your down payment to use gifted funds.
One loan type that permits the use of gifted funds is an FHA loan. If your loan is through the Federal Housing Association, then you’re able to pay the full 3.5% down payment with gifted money.
In some cases, you may be able to borrow money from your retirement fund, but you’ll want to be careful. Make sure you follow all rules surrounding this so that the IRS doesn’t find you or you receive a tax penalty.
#2. Keep a Low Debt Income Ratio (DTI)
With every type of loan, lenders will look at your debt to income ratio: the amount of debt you are currently paying off and the income you earn. As borrowers with a high DTI ratio are a risk for lenders, their applications may be denied.
While you may not be able to greatly change your DTI, it’s important to keep an eye on it and try to lower it before applying for a loan. Most lenders want borrowers with a DTI of less than 36%, though they may still accept your application if it’s between 36-42%. A DTI of 43% or higher makes your chances of being accepted slim to none.
If you aren’t sure what your DTI is or you’re worried it may be too high, here’s a helpful calculator that can help you get a clearer idea of what your current DTI ratio is.
#3. Don’t Use All Your Savings
Since many low-down payment loans come with PMI requirements or higher interest rates, it can be tempting to pay a higher mortgage to avoid this. While this can be a good idea, it’s not if it means you’ll empty your savings account.
A 20% down payment will secure you just about any loan type, but it’s not worth it if it means you won’t have any emergency money or extra cash.
You never know when an emergency will come up or when disaster may strike. If you don’t have anything in your savings to help cover it, then you may face worse consequences. As such, it may be better to stick with a low down payment and higher interest rates.
#4. PMI is Alright
Many low-down payment loans require the borrower to pay for private mortgage insurance (PMI) in addition to their loan payment. While this adds an extra cost to your loan, it’s important not to think of PMI as a bad thing. It’s simply there to help a lender if you default on the loan.
PMI doesn’t have to stay around forever and can be removed once you reach 20% of the loan. Check with your lender to see when PMI requirements are lifted and focus on paying off your loan, not how much the extra cost is.
Make Buying a Home Affordable
Low down payment loans can make buying a home affordable even for those who can’t commit to a 20% down payment. If you still can’t afford the down payment requirements for your loan, you may want to look into down payment assistance programs that can help you afford a home without using the last of your savings.
Homeownership is a big deal and you should be proud of taking the first step toward your dream. With a little bit of research and some time searching for the right lender, buying a home is within reach.