Twenty Percent Down Is Optional
A twenty percent downpayment is a hurdle which many home buyers will never have to overcome.
There are an increasing number of low-downpayment options for today’s homebuyer, including the Conventional 97, FHA home loans, and the zero-down VA mortgage.
And for good reason. The median home price in the U.S. was more than $220,000 at the end of 2015, according to the National Association of REALTORs®.
Making a twenty percent downpayment on the average home would require more than a $40,000 initial investment.
Many buyers don’t have — or don’t want to pay — that large of a sum upfront, but want to make a mid-tier initial investment when they buy. For them, a smart move can be taking a 10 percent down mortgage.
Fortunately, there are many options for buyers making half the “standard” downpayment.
Option 1: Conventional Mortgage With PMI
A downpayment of twenty percent eliminates the need for mortgage insurance on conventional loans.
But lenders will approve qualified buyers for a 10 percent down loan with the addition of private mortgage insurance, or PMI.
However, borrowers who put 10 percent down will receive reduced PMI compared to a borrower who puts down just three to five percent.
PMI rates also depend on your credit. For instance, a buyer with a 740 score will pay about $100 less per month on a $200,000 mortgage than would a 660-score buyer, according to mortgage insurance provider MGIC.
Lower-credit borrowers should compare their conventional loan monthly payment to what their payment would be with an FHA loan.
FHA mortgage insurance rates do not vary by credit score.
Monthly PMI premiums typically run between $30 and $70 for every $100,000 that you borrow according to Freddie Mac.
But that payment doesn’t last forever. When the amount left on the mortgage has an 80% LTV or less, you can cancel the PMI payments.
Option 2: An FHA Mortgage For Lower-Credit Consumers
FHA mortgages allow downpayments as low as 3.5% but allow higher downpayments to overcome a lower credit score.
According to FHA guidelines, a borrower can make a 10 percent downpayment and qualify with a credit score of just 500
A score of 580 is required for the minimum downpayment.
Keep in mind that many lenders create additional rules above and beyond what FHA requires. These rules are called “overlays.” So, some lenders will set higher minimum credit scores than does FHA itself.
Still, lower-credit home buyers can increase their chances of qualifying by putting 10 percent down on an FHA loan.
For those who qualify, there are two parts to mortgage insurance with FHA mortgages. You are responsible for an up-front amount of 1.75% of the home loan that is added to mortgage balance.
In addition, there is a monthly insurance payment, or MIP. In the past, MIP for FHA mortgages lasted about 11 years, or until the LTV reached 78%.
For most new FHA mortgages, MIP payments remain for the life of the loan. However, you can refinance an FHA mortgage and get a conventional mortgage that will probably have lower mortgage insurance interest rates.
Option 3: Conventional Piggyback Mortgage
A third 10-percent-down option is a piggyback loan. You take one mortgage for 80% of the home price, a second mortgage for 10%, and make a 10% downpayment.
The arrangement is often called an 80/10/10 piggyback loan.
These loans can take on different structures. For instance, a 75/15/10 is a loan in which the primary mortgage is slightly smaller, the line of credit is slightly bigger, and the downpayment remains the same.
The 80 percent first mortgage is usually a traditional 30-year fixed mortgage. The additional 10 percent second mortgage is often a variable-rate home equity line of credit, or HELOC.
The rate is based on the current prime rate, and is subject to change based on the federal funds rate which is set by the Federal Reserve.
Borrowers who want a stable fixed rate for their second mortgage can take out a home equity loan. The initial rate is typically higher than for a home equity line, but home equity loan borrowers do not have to worry about a rising federal funds rate in the future.
Home equity lines and loans are often opened by existing homeowners when they need cash for home improvements or other purposes. But they can also be opened at the initial purchase of the home.
Rather than using the money for another purpose, the entire loan amount is applied toward the downpayment.
The lender considers the HELOC part of the borrower’s downpayment, so there is no PMI necessary.
A piggyback mortgage can be a particularly good strategy for people who need to sell a previous home. The 80/10/10 lets them get into the new home, sell the old one, and then use some of the proceeds to pay off the equity line, leaving only the mortgage for 80%.