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 circ*mstances 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:
Stocks
Bonds
IRA
401(k)
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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