First Time Home Buyers Struggle for Down Payments
In the hot housing market that we are experiencing now in most parts of the country, we are hearing lots of comments about not having enough for a down payment for what is called a 20% down payment conventional loan. Home prices are moving up faster than savings. There’s plenty of confusion to add to the frustration in this situation as rates remain at historic lows.
The July 2021 report from Realtors® Confidence Index Survey, shows that 72% of first-time homebuyers put down less than 20% for their house purchase. In many cases, you don’t really need 20% down to buy a home if you have a good job and good credit. However, in a future housing market slump, it’s easy to find yourself upside down like millions of homeowners did in 2008. Buyers saw their mortgage balance was much larger than home value that might have fallen 25 to 50 percent.
Many would-be homeowners today are not only saving for that first home down payment, they are also saving for retirement and maybe college for children. So, is the 20% down payment conventional mortgage dead? Not quite, but there are alternatives to help buyers find homes they can afford to purchase.
Many of our clients live on either coast of the US where housing costs are high. A $750,000 home, if you can find one, means you need $150,000 for a down payment. That’s a big sum for most first-time buyers. But that number is only part of the need. House maintenance, repairs, and hidden defects cost money to fix so you need a healthy reserve we call part of your emergency fund. It seems something is always breaking, even in newer homes.
Adjustable-rate mortgages fit into the conventional loan zone and feature rates locked for one, five, seven or ten years. They still require 20% down but payments end up lower for the initial period. Many times, they will come with a lower teaser rate for the first year, so payments are even lower. These products fit well with buyers who don’t plan to stay in the home for 25 or 30 years or more.
Here are some smaller down payment alternatives but beware of other surprising costs and potential delays in approval and funding.
FHA (Federal Housing Administration) loans only require 3.5% down if you have good credit. 10% down if you only rate a fair credit score. In both cases, you will be required to pay 1.5% private mortgage insurance (PMI) adding to your cost of ownership. PMI can disappear after you exceed 20% equity in your home, but it is not automatic and can take a few months to qualify its removal. Also, an FHA inspector will visit and make sure your new home meets all federal construction standards. It’s not unusual to cause a delay and some sellers don’t want the FHA involved.
Other conventional loans are available for less than 20% down but those are usually directed at first-time home buyers. They are called Home Ready and Home Possible and are funded by Fannie Mae and Freddie Mac. They can feature down payments as low as 3% with added PMI again but without the dreaded FHA inspector. They do have higher credit score requirements than FHA loans.
VA loans are popular with military both active, retired, and veterans having served honorably. They feature no money down, but a sliding scale funding fee means you do need some cash to obtain this type of loan unless you are service-connected disabled or have been awarded the purple heart. Surviving spouses can also be exempt from this funding fee if their veteran spouse was service-connected disabled or died on active duty.
There are several other options to avoid having to save the total 20% down payment. They include gifts of cash from relatives or friends to meet the loan requirements.
A house purchase may include seller financing which means the seller takes your down payment and you sign a note to pay the rest over a stated period and at a certain rate. Sometimes there is a balloon payment due at the five- or ten-year mark, for example. That means the seller wants the outstanding balance paid at that point in time and you need to refinance. There’s a large risk that rates will be higher for these types of loans at refinancing time.
Lastly, private lenders like family or friends or a company like SoFi can provide non-traditional financing at lower rates and less paperwork. Down payments can be flexible, but companies like SoFi require PMI.
Who is your best source of home financing? I’ve found Realtors® to be a good, motivated resource since their goal is closing the deal and getting you the best deal too. Their reputation depends on it.