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Call it urban legend or just a persistent misconception from years gone by. In either case, the misplaced notion that a home buyer must save up for a 20% down payment is keeping many potential buyers from realizing their home ownership dreams.
A recent Ellie Mae survey found that nearly half of renters believe they need to put 20% or more down on a home purchase. But the reality is far from the myth. According to the National Association of Realtors, first-time buyers in 2017 made an average down payment of just 6–11%. Read on to learn that home ownership is indeed possible, without a 20% down payment.
Lower Down Payment Options AboundSo what gives? Lenders increasingly have recognized that as home prices escalate, saving 20% for a down payment is simply not feasible for many consumers. As a result, today’s home buyers have numerous low-down options that can put them in a new home. For example, FHA loans can be had for as low as 3.5% down. Some conventional mortgage loans also offer down payments in the 3–5% range. If you are a veteran or in the military, you might qualify for a VA loan with no down payment whatsoever.
Good Credit Is ImportantAs with other types of loans, your credit score plays a critical role in the options a lender can offer. Lenders use FICO credit scores as a way to assess risk. If you’d like your credit score to be a little higher before you start applying for loans, that might be a good choice. Most lenders will be happy to review your credit score with you at no charge, and even provide guidance on steps you can take to improve your score, if necessary.
Understand Home AppreciationYou’ll want to consider your area’s home appreciation rate, and compare that to the cost of mortgage insurance. Home appreciation is the increase in your home’s value over time and, in some cases, can be as high as 7–10%. A home purchase is often the biggest single investment you’ll ever make, so you’ll want to carefully consider the home appreciation rate and how that can improve your financial future.
Plan to Purchase PMIWhile a lower down payment will keep more cash in your pocket at closing, you should expect to add private mortgage insurance (PMI) to your monthly loan payment. PMI, also known as lenders insurance, protects the lender in the event of loan default or foreclosure. Lenders typically require PMI for conventional loans with less than a 20% down payment. PMI is calculated at about 0.5–1% of the total loan amount annually. For example, if you bought a home for $250,000 with 5% down, your down payment would be $12,500, leaving you with a total loan amount of $237,500. In this scenario, your estimated monthly PMI payment would be $106.88. Private mortgage insurance rates do fluctuate depending on the borrower’s FICO score as well as their debt-to-income ratio. In this example, we used a FICO score of 720 and a debt-to-income ratio of 34%.
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