How Millennials Are Buying Houses With Less Than 5% Down
A down payment of 20% has been, and continues to be, the industry standard for a new mortgage. However, it's important to realize that there is a big difference between an industry standard and a set-in-stone requirement. In fact, since the housing and credit markets have improved dramatically since the Great Recession, there are several ways you can buy a house with less than 5% down.
The 3% down conventional mortgage
After a period of tight credit following the financial crisis, government-sponsored enterprises Fannie Mae and Freddie Mac began to bring back low down-payment conventional mortgages. Since 2014, conventional, fixed-rate mortgages have been available with as little as 3% down.
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It's important to point out that Fannie and Freddie don't originate mortgages, they buy mortgages originated by banks that meet their lending standards. To get a 3% down conventional mortgage, you'll need to find a lender that offers them. Fortunately, most of the major U.S. mortgage lenders do -- often under their own brand names, such as Wells Fargo's yourFirstMortgage loan.
To qualify for a 3% down conventional mortgage, the current guidelines require a minimum FICO credit score of 620, along with your income, employment record, and your assets. As a senior Fannie Mae official confirmed shortly after these mortgages began to be offered, a buyer with a 620 credit score is unlikely to qualify, unless he or she has a stellar income, lots of money in reserves, or some other offsetting factor. In addition, the loan amount cannot exceed Fannie Mae and Freddie Mac's "conforming" maximum -- $424,100 for most locations in 2017.
The majority of people who get approved for a conventional mortgage have credit scores in the 700s or better. Many lenders have minimum standards that exceed those set by Fannie and Freddie. The only way to know for sure if you'll qualify for a 3% down conventional mortgage is to talk to a lender (or several), and complete the pre-approval process, which is a good thing to do before you start shopping for a home.
Finally, be aware that if you get a 3% down conventional mortgage, you'll be required to pay private mortgage insurance (PMI), at least until your loan-to-value is paid down to 80%.
Even if your credit isn't great, the 3.5% down FHA mortgage may be an option
As I mentioned, the minimum FICO credit score required for a conventional mortgage is 620, as of this writing. A credit score above that threshold is no guarantee of approval.
Fortunately, the FHA mortgage may be a good option for buyers who can't qualify for a conventional loan. Many lenders that originate conventional loans also offer FHA loans, and that option is worth considering if your qualifications aren't quite up to par for a conventional mortgage. The down payment requirement of 3.5% is slightly higher, but it can also come from other funding sources, such as a gift.
If you're looking to put 3.5% down, you can get an FHA mortgage with a credit score as low as 580. And while FHA loans also consider other factor, such as your income, employment, and assets, it tends to be easier to get a FHA loan, especially if your credit is just above the minimum requirement.
In addition, FHA loans can be made on one- to four-unit properties, whereas the 3% conventional mortgage is only available on single-unit, owner-occupied homes. In other words, you could use an FHA loan to buy a duplex, live in one side, and rent out the other to help cover the mortgage. Just like conventional mortgages, FHA loans cannot exceed the limits set for the home's location. As of 2017, the FHA loan limits range from $275,665 to $636,150.
The downside to an FHA loan is the cost. It's true that the FHA mortgage insurance rate of 0.85% of your loan balance (on a 30-year loan with the minimum down payment) is competitive with the private sector, but unlike conventional loans, you won't be able to simply cancel the FHA mortgage insurance after paying some of the loan down -- it will remain for the life of the loan. Furthermore, you'll pay an upfront mortgage insurance premium as well, currently equal to 1.75% of the loan amount. This can be rather expensive -- on a $250,000 mortgage, this is a $4,375 added expense.
Zero down for veterans and rural homebuyers
Another way to buy a home with less than 5% down applies to veterans and certain homebuyers in rural areas -- buyers who qualify don't have to put any money down.
VA loans are available to veterans and active-duty military personnel. Not only do these loans require no down payment, but they typically have a slightly lower interest rate than buyers could get on the open market, and they have no mortgage insurance requirement. Here's a full list of requirements from the Departments of Veterans Affairs that can help you determine if you qualify.
USDA loans are available to buyers in certain rural areas whose income is under the limitations for their home's location. They require no down payment, but there is a "guarantee fee" that must be paid upfront and annually, similarly to FHA mortgage insurance. You can find out whether a home might qualify for a USDA loan here.
Check with your bank or credit union
As a final thought, many lenders and credit unions have their own lending programs designed to make homeownership more accessible to otherwise qualified buyers who don't have a lot of cash to put down. For example, Regions Financial offers 100% financing to buyers with excellent credit through its "Affordable 100" program. These loans don't require mortgage insurance, but buyers can expect a higher-than-average interest rate to compensate the bank for taking on the added risk.
In addition to the other options I've discussed, it's a good idea to check with some banks (national, regional, and local) and credit unions to see if they have any unique loan programs that might be a good fit for you.
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Matthew Frankel owns shares of Regions Financial. The Motley Fool has no position in any of the stocks mentioned. The Motley Fool has a disclosure policy.