Mortgage Minute: Understanding Downpayment Requirements
- September 2, 2019
- 3 min read
- 22 reads
The number one barrier that potential homebuyers say they face is saving up for a downpayment. While saving up a large sum of money can be difficult and take time, don’t let common downpayment myths hold up your dreams of homeownership!
First, let’s dispel a few down payment myths with some downpayment facts:
- You aren’t required to put 20% down on a primary home purchase, though you may have to pay for mortgage insurance (we’ll discuss this more later).
- Your downpayment funds do have to come from an approved, documented source — no “mattress money” that you’ve saved up in cash. TIP: If you have been saving up cash, consider depositing it into an FDIC or NCUA insured checking or savings account at least two to three months prior to your home purchase.
- 100% financing or “zero” downpayment programs are generally limited to VA loans, or involve securing funds from a downpayment assistance program.
- Gift funds from a family member or close relative
- Crowdsourcing platform funds – as long as they’re documented
- Downpayment assistance programs with varying repayment options
- Cryptocurrencies – will need to be converted to US dollars
- Funds from foreign bank accounts – additional documentation and translation may be required
- Joint accounts – will need a letter from other account holders granting access to the funds
Downpayments Requirements Explained
If you’re going to purchase a home and get a mortgage from a lender to do so, most mortgage lenders require that you make a direct contribution from your own funds towards the purchase price. This is usually calculated as a percentage of the agreed upon purchase price for the property, though it could increase if the appraised value of the property comes in lower than that.
For conventional loans (i.e. those backed by Fannie Mae and Freddie Mac), current guidelines require homebuyers to contribute 3% to 5% of the home’s purchase price in order to secure a loan. Note: the 3% downpayment programs are subject to additional qualifying criteria including area median income requirements and are geared towards first-time homebuyers.
For FHA loans (i.e. those insured by the Federal Housing Administration) the required minimum downpayment is 3.5% of the purchase price. If your credit scores are below 580, this increases to a minimum downpayment of 10%.
For VA and USDA loans (i.e. those backed by the Veterans Administration and U.S. Department of Agriculture, respectively) there are zero downpayment options available. VA loans are reserved for eligible U.S. military veterans and their spouses only. USDA loans are for use in eligible rural areas, determined by the USDA’s Eligibility Map.
Why Lenders Require Downpayments
The most important reason that mortgage lenders require you to make a downpayment is to ensure that you have a vested interest in making your monthly mortgage payments. Their way of thinking is that the more you have invested into the property, the less likely you are to default on your payments or allow the home to go into foreclosure. Having an immediate equity stake in your property makes you a less risky borrower.
Let’s Talk About Mortgage Insurance
If you’re planning on putting less than 20% down on a conventional loan or an FHA loan, then you may be required to pay an additional monthly insurance fee called mortgage insurance. Conventional loans call this fee Private Mortgage Insurance (PMI) and FHA loans call the fee Mortgage Insurance Premium (MIP), but both are based on the same premise of insuring the lender in case you don’t make the payments and default on your loan.
The amount of mortgage insurance required depends on your credit scores, your loan-to-value ratio, and your overall debt-t0-income ratio — though other financial factors may affect this too.
Tip: For conventional loans, once your loan-to-value reaches 78% the mortgage insurance is required to drop off automatically. You can also make a formal request that the mortgage insurance be removed once your loan-to-value is 80% or less, but the decision to remove it is up to your lender or loan servicer.
Tip: For FHA loans, the mortgage insurance could be required for a minimum number of years, regardless of your loan-to-value at that point in the loan. It could even be a permanent feature, requiring you to refinance into another loan product in order to eliminate it.