Demand for housing remains strong as we enter the spring season, and renters are finding that it may cost them less to buy a home than to rent. But if you don't have a lot of cash and are looking to purchase your first home this year, you may find that you need less cash than you think.
It was standard to have 20% down to purchase a home 20 years ago. Today, putting down 20% does still give you the lowest possible payment in relationship to the cost of the house, but it is by no means a requirement, nor should it be thought of as the be-all and end-all for purchasing your first home.
The magic down payment amount you can have to purchase a home is — drumroll, please — 0%, no money down. You do not need a down payment to purchase a house. Alternatively, a 3%, or more common a 5%, down payment can help strengthen your offer. Also, a loan insured by the Federal Housing Administration requires a 3.5% minimum down payment. There are programs that can help get a first-time buyer in the door all with a 30-year fixed-rate payment containing no banking prepayment penalties or hidden terms. (Keep in mind that you're considered a first-time homebuyer if you've not owned a home in the past three years.)
Let's look at what other loan types require a low (or no) down payment.
1. USDA Mortgage
The U.S. Department of Agriculture allows people in less industrialized areas to purchase a home without putting any money down. You'll need the cash for closing costs or you can ask the seller for the credit for closing costs. The loan allows a buyer to purchase a home up to the conforming loan limit working with the standard $417,000 conforming loan size. As long as you can qualify, the program does not require a down payment.
2. Conventional Mortgage
The more traditional mortgage loan program recently announced it will accept as little as 3% of the purchase price for a down payment. Similar to USDA, the qualifying standards with the 3% down option are more stringent than if you were working with the more common 5% down payment option. Investing 5% down will cast a wider net for you in the marketplace because of how much stronger you look on paper. And the 5% down option is available all the way up to a maximum conforming loan size of $417,000. If your loan amount exceeds $417,000 for single family home, you'll need at least 10% down with conventional financing as your loan considered to be conforming high balance, aka a "jumbo" loan.
3. FHA Mortgage
The FHA insures mortgage loans with as little as 3.5% down payment all the way up to the maximum conforming loan limit. The conforming loan limit does surpass $417,000 in several markets — for example, in Sonoma County, Calif., it's up to $520,950. The FHA has risen in popularity as the ability to qualify for such financing is incredibly lenient. The FHA routinely signs off on previous unfortunate circumstances including short sale, foreclosure or even bankruptcy in the last few years.
Don't Forget the Cash You'll Need for Closing
While it's true you don't need money for a down payment to purchase a house, the transactions that are actually closing in strong real estate markets are the transactions supported with strong homebuyers coming in with at least a 3.5% or 5% down payment. Closing costs are another factor to take into consideration that go beyond your down payment funds in procuring a mortgage to buy a home. If you can come up with the down payment, you can always ask for a seller credit for closing costs or even obtain gift money from family if cash is still tight. Total closing costs on average can be about 2.5% of the purchase price. (You can use this calculator to see how much house you can afford.)
Here's a range of closing costs when buying with less than 20% down:
- For a home purchase between $500,000-$600,000, you'll need at least $10,000 for closing costs
- Between $300,000-$500,000, at least $8,000-$10,000 for closing costs
- Between $150,000 $300,000, at least $7,200 for closing costs
These numbers should give you an idea of how much cash you'll need for a home purchase. Acceptable sources for procuring cash to close on a house can be one or any of the following:
- Checking/ savings
- A money market account
- Retirement account
- Gift money
The key here is that the money needs to be documentable.
Don't have cash available from any of the above-mentioned sources? Even these sources are still considered acceptable because they can be paper-trailed:
- Security deposit refund on your current home rental
- Tax refund
- Any money you might have sitting in a safe at home can actually be used for the transaction as long as the money is deposited in a bank account and sits for 60 days to meet banking "seasoning" requirements.
- Selling of personal property such as a car or motorcycle. This cash can be used but will need to be documented with a bill of sale and a bank account matching the funds deposit.
- A loan against a retirement account to come up with the down payment is also OK, but the lender will need to be provided with the borrowing terms of the 401(k) loan.
Homebuying tip: Line up the cash before you go house hunting. Have a statement showing proof of funds to close that you can submit with your pre-approval letter when you identify a house you want make an offer on, especially if cash is tight. At the same time, it's a good idea to check your credit to see where you stand, and to look for any errors that you may need to correct. You can get a free summary of your credit report on Credit.com, plus two truly free credit scores.
Being a first-time homebuyer today does not carry additional tax benefits or incentives like it did a few years ago when the federal government was trying to bolster homeownership in leaner economic times. The ability to purchase a home as a first-time buyer in today's real estate market means working with a traditional mortgage loan program and having money in the bank to best position yourself for not only being a responsible borrower, but also demonstrating you have the merit and capacity to purchase a home.
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