Have you heard that you need to put 20 percent down on a home purchase? If you’re like most home buyers, you’ve probably heard this a few times already. That rule of thumb comes in handy for a few reasons. For one, you’ll avoid PMI when you put 20 percent down. And you’ll have smaller monthly mortgage payments because your total mortgage amount will be smaller.
However, while a 20 percent down payment is nice to have, it’s not always realistic. If you’re in a competitive housing market where prices jump every year, you might not be able to save up that much. So what should you do?
Here’s the good news: you don’t need to put down 20 percent to buy a home. In fact, the National Association of Realtors reports that the average down payment was just 11 percent in 2016. Here are some alternatives for those who don’t want to put 20 percent down.
Why You Might Want an Alternative to 20 Percent Down
For most people, putting down less than that recommended 20 percent is a simple matter of affordability. It’s tough to come up with that much money in cash (without running into some financial no-nos, like draining your retirement accounts or pulling from your emergency savings).
And don’t forget that on top of a down payment homebuyers also need to cover closing costs, which also need to be paid for in cash. The total of your closing costs can add up to an extra 3-6 percent of the purchase price.
Even if you do have enough cash to make a 20 percent down payment, you may want to hold onto some of it. A house is an illiquid asset, meaning you can’t (easily) get your money back out of it. It takes time and effort to sell, and even then, there’s a risk you may end up underwater if your home value drops.
Equity is usually a good thing — but so is liquidity. Putting down less than 20 percent allows you to keep more cash on hand, which is always good for emergencies. And you may get a better return for your money if you put cash into the stock market rather than throwing it into a home purchase.
5 Alternatives to a 20 Percent Down Payment
If you’re ready to buy but don’t want to wait until you get 20 percent of a home’s purchase price in cash (or just don’t want to use that much cash upfront), here are five alternatives to putting down 20 percent.
1. Private Mortgage Insurance
Conventional mortgage lenders don’t require that you have a 20 percent down payment to buy a home. To offset the risk associated with a lower down payment, they require that you have a private mortgage insurance policy (PMI) to protect them in case you default.
Usually, PMI costs $30 to $70 per month for every $100,000 that you borrow. You could pay a couple hundred dollars per month for PMI if your home is expensive. You may not love the added cost, but you’ll need to pay it for a few years. Once you pay down your mortgage balance to 80 percent of the home’s value — or once you have at least 20 percent equity in your home thanks to a rise in value — you can ask to have the PMI removed.
2. FHA Loan
If your FICO credit score is at least 580, you can qualify for a mortgage loan insured by the Federal Housing Administration (FHA) with just a 3.5 percent down payment. On a $200,000 home, that’s just $7,000.
The main drawback to FHA loans is that you have to pay two mortgage insurance premiums (MIP). First, you’ll pay an upfront MIP of 1.75 percent of the loan amount when you close.
Then, you’ll pay an annual MIP of 0.45 percent to 1.05 percent, depending on the size of your loan, your loan term, and your down payment amount.
Unlike with PMI, you can’t appeal to have the MIP removed. In most cases, it stays for the life of the loan. That said, you do still have one other option: it’s possible to refinance your mortgage down the road to get rid of it.
3. USDA Loan or VA Loan
If you plan to buy a home in an eligible rural area, you may be able to qualify for a loan insured by the U.S. Department of Agriculture (USDA). These loans require no down payment at all, and it’s not quite as expensive as PMI on a conventional loan and MIP on an FHA loan.
You’ll pay a 1 percent fee upfront and a monthly mortgage insurance premium of 0.35%. Keep in mind that there are also income requirements for a USDA loan. Check out the eligibility site to see if you qualify.
If you don’t qualify for a USDA loan, check into a VA loan. In most cases, you don’t need any down payment for these mortgages.
4. Piggyback Mortgage
If you want to avoid paying mortgage insurance of any kind, another option to consider is piggybacking two mortgages to meet the 20 percent down payment.
You could take out one mortgage for 80 percent of the home value to avoid PMI, take out a second mortgage for 10 percent of the home value and put down 10 percent in cash. This is also called an 80-10-10 loan.
The main drawback to this option is that you’re paying closing costs on two separate mortgage loans and your monthly payment could be quite high. It can also get complicated if you want to refinance your mortgage down the road. You’ll need to consult with a mortgage professional to make sure the savings work out in your favor.
5. Homeownership Investment Programs
A final way to get out of saving 20 percent of your new home value is to avoid borrowing more money by partnering with a third party to make an investment together. Companies like Unison will give you cash upfront for your down payment through programs like the Unison HomeBuyer program.
In return, Unison receives a share of the future change in value of your home when you sell it. You can also choose to buy out the company in the future with a lump sum if you don’t plan on ever selling the house.
Depending on the home ownership investment program or company you work with, you may need to pay a transaction fee upfront. But you won’t take out additional loans, nor will you owe interest on the money the third party invested with you. Learn more about home ownership investments here.
You Don’t Have to Put 20 Percent Down When You Buy a Home
The 20 percent down payment rule may be a guideline, but it’s not a mandate. There are several options available to people who can’t afford to save that much or simply don’t want to part with that much cash.
Before deciding which one is right for you, carefully consider all the options and consult with a mortgage professional or a financial planner to make sure you explore each one thoroughly.
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