How to finance your home purchase without putting 20% down
Empowering homebuyers through education
At RateGravity, we are honored when given the opportunity to conduct home buyer classes because it gives us the chance to live one of our core values, which is to provide unbiased educational content.
During several of our most recent classes, we have heard a consistent theme from many potential homebuyers that we refer to as “the misconception of 20% down”. Specifically, this is the mistaken belief that you can only buy a home if you have 20% of the purchase price saved for a down payment.
In fact, the National Association of Realtors most recent HOME Survey showed that 37% of those 34 years or younger believe they need more than 20% for a down payment, and only 13% believe they need 5% or less.
The purpose of this article is to dispel this common misconception by explaining the options available for you to achieve the dream of home ownership without having to come up with 20% for a down payment.
What is a down payment?
A down payment is the personal cash contribution that you make in a purchase transaction. Programs exist for down payments as low as 3% for one-unit properties that you intend to occupy as your primary residence, however the best loan terms come with down payments of at least 20%.
It is important to note that if you are purchasing a home that you will not occupy as your primary residence (i.e. second homes or investment properties) the opportunity to buy the property with less than 20% down, may not be available. The factors that will determine if this is possible are the number of units and type of mortgage (i.e. Adjustable Rate Mortgage or Fixed Rate Mortgage).
How can I buy a home with less than 20% down?
There are two ways that you can buy a home when putting less than 20% down: paying for mortgage insurance or securing a second loan.
Mortgage Insurance
Mortgage insurance reimburses the lender if you default on your home loan. You, the borrower, are responsible for paying the premiums. If the policy is sold by a company, it’s known as private mortgage insurance (PMI). The Federal Housing Administration and state-sponsored government agencies also sell mortgage insurance. In both cases, the lender will secure the policy as part of the transaction and the details will be shown in your disclosures and closing documents.
Mortgage insurance can be paid upfront and/or in monthly installments. There are also options whereby the lender will pay the PMI premium(s) on behalf of the borrower, however this will result in a higher interest rate on the loan. For the monthly installment programs, you will make the payments as part of your monthly mortgage payments.
The lender is required to cancel your private mortgage insurance payments when the loan-to-value ratio drops to 78%. In some cases, your lender will accept a request to drop the policy when the loan-to-value ratio reaches 80%, but they are not required to do so. Recent FHA-insured loans require payment of mortgage insurance premiums for the life of the loan. FHA mortgage insurance premiums cannot be canceled unless you refinance your loan into a non-FHA loan.
Subordinate Financing
Certain lenders will allow you to put less than 20% down and avoid mortgage insurance by combining your first mortgage with a second mortgage. This second mortgage is sometimes referred to as a “subordinate” loan because in the event of a default, the first mortgage owner is entitled to repayment before the second mortgage is repaid.
In some instances, a second loan will result in better terms than getting a single loan with PMI. A common structure for subordinate financing is the 80–10–10, where the “80” refers to the percentage of the purchase price provided by the first mortgage, the first “10” refers to the percentage of the purchase price provided by the second mortgage and the final “10” refers to your down payment.
The 2nd mortgage or subordinate financing typically consists of a variable rate home equity line of credit (HELOC) or a fixed rate loan. The rate on the second mortgage is almost always higher than the rate on the first mortgage to compensate the subordinate lender for the additional risk associated with a smaller down payment, but it is not uncommon for the combined payments to be less than a single loan with mortgage insurance.
Homeownership is an integral part of the American dream, but too often people are missing out because they believe it is an unattainable goal. However, with rising rents that often include big upfront payments (first and last month’s payment and a security deposit) there are situations where homeownership is actually more affordable than renting. This is made possible by the tools available to get a mortgage without having to put 20% down.
