It took me a lot longer to buy a house than it should have, largely because I was mistaken about how much of a minimum down payment I needed in cash to be able to buy a home. Family had filled my head with the belief that I needed a 20% down payment to be a homeowner. However that turned out to be incorrect information.
With the belief that I needed to save a lot of money, it simply took me much longer to reach my goal than was necessary. I want to share my knowledge with you in this post to help you with your own house purchase and clear up any confusion you may have concerning the mortgage down payment.
Down Payment Percentage
The first thing that you need to understand about buying a house is that different types of loans may require varying down payment percentages. If you or your spouse are current or former miliary in the USA, you may qualify for a VA loan that offers a 0% down payment! For everyone else, the minimum down payment rate you'll be able to get is 3% - 3.5%.
Conventional home loans can sometimes offer you a minimum down payment of 3%. However, that amount is also restricted based on your credit score and other factors. If your credit isn't that great, you may need to put down 5% with a conventional mortgage.
FHA loans offer 3.5% minimum down payments. If you do not have a credit score of at least 580 but are still above 500, you may still qualify for an FHA loan but it will require 10% down for lower credit.
Private Mortgage Insurance
The most likely reason why I was led to believe I needed at least a 20% down payment to buy a house was because of private mortgage insurance (PMI). You can buy a less with less money up front, but you'll pay for private mortgage insurance. Different types of loans may have different rules concerning PMI though.
With a conventional loan, you'll probably only need to keep paying PMI until your equity reaches 20% of the loan value. With a really low down payment, this take 10 years or more. However, if you put 15% down, you wouldn't have to pay the extra PMI for more than a few years.
FHA loans work different though. No matter how much you put down, even if it is over 20%, you still pay PMI on FHA loans for 12 years. For this reason, if you were able to pay 20% you would be much better off with a conventional mortgage.
Extra Mortgage Cash
It is really easy to get blindsided by the large amount of cash needed for the down payment and not consider other expenses. When you're buying a house, you quite frankly need a lot of extra money beyond your down payment amount.
When you close on the house, that is when you pay for the down payment and some other expenses. Closing costs are due at that time, and they can be pretty expensive. Closing costs vary from state to state, but they're usually in the range of 3% - 6% of your loan value. That means that with a low down payment, closing costs could actually end up being even more than the down payment itself!
As if that wasn't enough, you'll still need money to cover inspections and moving expenses. Once you finally get into your new home, you'll have to be able to afford your mortgage payment too. Even though you'll usually have 30-60 days after moving in until you make your first payment, lenders still like to see you with at least a few months' worth of mortgage payments in the bank after the other expenses are paid. The exact amount you'll need will depend on your situation, but it's a safe bet that you'll need a lot of extra cash besides the down payment to actually buy a home.
Saving for a Down Payment
There are a lot of different ways that you can save money for a mortgage down payment. Get frugal with your spending and try to live as minimalistic and cheap as possible to allow you to save a larger percentage of your income. These days, house prices are appreciating so rapidly that it probably feels like you're falling behind each month even while saving a lot of money. Don't get discouraged though - keep saving and hopefully prices will go down by the time you're ready to buy.
One of the best ways to quickly save a down payment is to make extra money. Get a second job or start a side hustle to increase your income. If you were able to afford to live without this additional income, you can contribute 100% of it towards saving to buy a house.
Anyone that already has a retirement account may be tempted to make an early withdrawal to buy a house. However, this really isn't a great idea because of all of the extra costs involved and the long-term harm you'll do to your retirement funds. You can decide to stop your retirement contributions for a short period of time though. I'd recommend no more than two years of diverted funds can go towards buying a home, but make sure you resume contributions as quickly as possible.
Down Payment Family Gift
Some lucky people may have a family member or very rare friend that is willing to give them enough money or part of the cash needed for a down payment. This is allowed with mortgages and won't count against you. However, the gift will need to be documented for your lender to allow it.
In general, any money that you will want to use towards buying your home will need a paper trail. Lenders will want to know where your down payment cash came from, and they'll want proof too. When it's a family member gifting you the money, they'll need to provide a signed statement that says they have given this money to you as a gift. In fact, the lender will likely also want to see bank statements from that family member that shows them gifting you the money and also shows where it originated too.
Using Loans for Down Payments
One of the main reasons why lenders will want documentation and bank statements to show where your money came from is to ensure that you didn't take out a loan to get it. It isn't against the rules to borrow your down payment funds. However, you have to disclose that fact so the debt can be factored into your application.
Since debt-to-income (DTI) ratio is a major factor in approving a mortgage, a down payment loan would result in a monthly payment to repay it, and that monthly payment will need to be considered. If your DTI is already borderline, you definitely won't have the wiggle room to take out a loan to get the money you need for the down payment minimum.
Ultimately, this option really won't work for most people unless you have low debt, high income and/or a low house purchase price. Even though undisclosed, private loans may not be noticed by your lender, you really don't want to lie on a mortgage application either.