If it is your first time buying a home, or even if it isn’t, it can be easy to feel overwhelmed by the amount of information circulating on the journey, and everyone loves to give their own two-cents when it’s you in the driver’s seat. One of the biggest questions asked at the beginning of the home buying process is “how much cash do I need for a down payment?” While there are a lot of conflicting pieces of advice, we would like to clear the air on how modern down payments typically work.
The 20% Myth
There was a point in time when 20% of the total cost of the home was the standard for down payment requirements. Though many people still tout the 20% rule, it simply is not the standard for buying a home any longer. The reason for the shift in this standard is clear when looking at the facts and figures. In 1980, the average cost of a home in Texas was $61,300 which would bring your 20% down payment to $12,260 dollars – doable with a little saving and financial planning. However, today the average home cost in Texas now at $211,199 which would bring that 20% down payment to a whopping $42,239. If this was the minimum standard for buying a home, most Texans would consider home ownership unattainable.
More than cash in hand, most lenders pay more attention to your credit score and debt to income ratio when giving out loans. This shows potential lenders how fiscally responsible you are and what you can afford based on your finances. The truth is, the minimum amount of the most commonly obtained home loans do not even come close to 20%. Below are the top loan types utilized in the home buying process and the down payment percentages typically required for them.
Conventional loans are the most commonly used loan types, and unlike the others on this list, conventional loans are not backed by the federal government. Lenders are typically more lax on requirements for loans that are backed by the government because they will not be held financially responsible if the borrower fails to pay their loan. Conventional loans are given by private lenders, and their requirements for your financial health is a little more strict than that of the FHA loans.
With a conventional loan, you can often qualify with as little as a 3% down payment, and sometimes you can find a lender with 0%, however, you will have to pay the Private Mortgage Insurance (PMI). PMI rates usually fall between .5% to 1% of the total loan and it is typically paid annually. Because a 20% down payment does give the lender a little more faith in your financial situation, those borrowers are not required to have a PMI. However, once you reach 20% in equity after paying on your loan, you can typically have that PMI removed.
FHA loans (Federal Housing Administration) are popular for first time home buyers because they typically require a lower minimum down payment, are a little more lax on credit ratings, and often have lower to no closing costs. With most FHA down payments coming in at as low as 3.5%, home ownership can feel a little more in reach to many. There are a few caveats with the FHA loan, though. For starters, not all lenders are able to offer FHA loans, and your borrowing limit will likely be less than it would be from a conventional loan. Also, you will likely be paying your mortgage insurance premium (MIP) for the entire life of the loan, which is typically 30 years.
These loans are specific to properties in rural and urban areas and are often more accessible for lower income individuals. A 640 credit score can get you automatically through their underwriting system, but a lower credit score does not mean you can’t get a USDA loan. Approval below a 640 FICO score will be determined by the lender you work with. USDA loans do not require a down payment, so your ability to get a loan will not be halted by your personal lack of cash flow. If you are curious about a specific property, you can use the USDA’s website to determine if it is eligible for their loan.
VA loans are backed by the U.S. Department of Veterans Affairs and are available for but not limited to active service members and veterans of the US armed forces and National Guard, those who were honorably discharged, and unremarried spouses of service members who are missing in action, a prisoner of war, or killed in active duty. VA loans do not have a minimum FICO credit standard but allow the lender to evaluate the borrower on a more person to person basis. While most VA loans do not require a down payment at all, a down payment might be necessary if the purchase price exceeds the appraised value of the home or you exceed the loan limit. In these cases, you might be required to make a down payment that covers the difference.
While most loans do make it easier to begin the process of buying a house with lower down payment requirements, that is not the only cash you will likely need before it is all said and done. Before you can buy a house, you typically need to pay for many various services like the appraisal, inspection (possibly several depending on the home), survey, earnest money, option fees, closing costs, and more.
While your closing costs and earnest money will vary depending on your loan and the seller, many of the other services and inspections that are required by your lender can run around $500 a piece. And while it might be tempting to just throw some of those services on a credit card, you should avoid making changes to your credit limit or balance at all costs. Increasing your debt before closing on a home, even by a little, could cause your loan to get denied.
It’s important to know exactly what you will need going into the home buying process so you don’t end up in a frustrating or financially difficult situation. Instead, you can approach home buying prepared and come away with the home you dreamed of! If you have any questions about loans or homes for sale in Lockhart TX, contact Lone Star Realty, a Lockhart real estate agency, for more information.