Do First Time Homebuyers Need a Down Payment?

By Arlene Isenburg on November, 5 2021
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Arlene Isenburg

Years ago, there was a belief that buyers should pay a 20% down payment when buying a home. But that thinking has gone by the wayside, and there are loan programs designed to help buyers afford a home with less. Let’s explore down payment options for first time homebuyers.

Do I Need a Down Payment to Buy My First House?

The answer, of course, depends on the kind of loan you get. But no, you do not need a down payment to be able to buy a home. There are a number of ways in which first-time buyers can pay low or no down payments. Let’s explore the most common of these loans and whether you are required to pay private mortgage insurance (PMI), which is typically required for down payments under 20%.

The loan programs that allow for zero down payments are VA loans and USDA loans, but both have special requirements in order to be eligible. And don’t forget both still carry closing costs that buyers are responsible for.

VA Loans

Backed by the U.S. Department of Veterans Affairs, these loans are only available to members/veterans of the military and their spouses, VA loans have no down payment requirement, are flexible with credit scores (typically over 580) and other credit-related issues (such as bankruptcies) and offer below market interest rates. There is also no limit to the loan amount. PMI is not required, but borrowers do have to pay a guarantee fee, which can be absorbed into your loan principal (the balance of your loan) to be paid off over time instead of as a one-time payment.

USDA Loans

A USDA loan, also called a “Rural Housing Loan,” was meant to encourage home-buying in rural areas, but it is also an option for suburban buyers. These loans do not require a down payment but typically require a credit score of 640. Backed by the U.S. Department of Agriculture (USDA), interest rates are low (below-market and better than some low down payment loans), and there is no limit to the price of the home. There is a guarantee fee, but it can also be absorbed into your loan principal. There is an income limit of 115% of the local median income, and borrowers must pay PMI, but the PMI for these loans tend to have lower fees than FHA loans.

If you don’t qualify for one of the above loans, there are also loan programs that allow for low down payments which have less restrictive eligibility requirements than the zero down payment options.

FHA Loans

FHA (Federal Housing Administration) loans require only 3.5% down. These loans are insured by the Federal Department of Housing and Urban Development (HUD), which also determines rules and guidelines for these loans. But FHA loans are offered not by the FHA (which is part of HUD), but by traditional, private lenders. Since the loans are backed by the FHA, this loan program allows below-average credit scores (typically a score of 500 with 10% down or 580 with 3.5% down). There is no requirement regarding the source of your down payment, meaning it came be paid with down payment assistance or gift funds. But PMI is required, and the home needs to be your main residence. There is a loan maximum up to which the FHA will insure--$822,375 in high cost areas like New York City.

The Conventional 97 Loan

Available to borrowers with a credit score of at least 620, this loan requires a 3% down payment and often costs less than an FHA loan. Backed by Freddie Mac and Fannie Mae, it allows buyers to pay for the entire down payment with gift funds. But there are some restrictions. The home must be a single family dwelling, you must have a fixed-rate mortgage and there is a loan maximum of $548,250 regardless of location (i.e. a high cost area, as previously mentioned).

Conventional Mortgages

Similar to but less restrictive than the Conventional 97 loan, standard mortgages require a 5% down payment and are also available to those with a 620 credit score. This is the most popular loan available due to its down payment flexibility and broad eligibility requirements. Conventional mortgages also have higher loan maximums than some other loans, such as FHA loans. PMI is required but only until you reach 20% equity.

HomeReady and Home Possible Mortgages

Designed for low-income and multi-generational families (but available to everyone who meets the income requirements), these loans require a 3% down payment. These conventional loan programs are offered by most traditional lenders but are backed by Fannie Mae and Freddie Mac, respectively, and may require borrowers to enroll in an educational course. Buyers using these loans get lower PMI fees, mortgage rate discounts and below-market rates and are allowed to use the incomes of multiple residents to meet the lender’s income requirements.

If you are not eligible for a zero down payment loan and need help with your down payment, there are options to help with the cost.

Down Payment Assistance Programs

There are over 2,500 Down Payment Assistance Programs across the country that help low income and first-time buyers afford their down payment which can cover all or some of the down payment. Offered by nonprofits, state/local governments and even employers, buyers can get low-interest/no-interest loans for down payments and closing costs. There are also grants and loans that don’t have to be paid back at all, or at least not if you live in the home for a certain amount of time or meet other requirements.

Borrow from Retirement Funds

You can borrow up to $50,000 from your 401(k) and $10,000 from your Roth IRA. But borrowing from your future has consequences. In addition to taking money from your retirement savings, you could face taxes/penalties or need to pay the loan back if you leave your job.

Get a Piggyback Loan

Also called an 80-10-10 loan, you can put down less than 20% and avoid PMI. With a piggyback loan, you would have two loans--typically, a mortgage for 80% of the price of the house and a second loan for 10% that piggybacks on the first loan. That leaves 10% that you would be responsible for as the down payment. Piggyback loans tend to have higher interest rates that can increase over the life of the loan, and they can complicate a future refinance.

Seller Financing aka Seller Carry

This is a kind of rare piggyback loan in which the seller carries the second loan instead of the buyer. With the seller as the “lender,” the loan is often shorter-term, has smaller monthly payments and has a balloon payment with the entire balance due several years after closing.

Borrow Against the Equity in Another Property

With this low cost possibility, you can use your equity in an existing house to help you buy a second. A lump sum home equity loan is the most popular way to fund a down payment, but there are also home equity lines of credit and cash out refinances.

Help From Friends or Family

Many lenders allow gift money to be used for at least part of a down payment, but you must provide documentation showing that it was a gift and not a loan. If you have family or friends generous enough to help with your down payment, this may be the best financial option. But lenders may take gift funds into account when deciding to give you a loan.

Personal Loan

Lenders tend to prohibit personal loans from being used for a down payment, though there are rare exceptions. And there is a point in time when borrowed money is no longer considered borrowed and becomes yours. That point is typically 60 days, depending on the lender, when the money is considered “seasoned.”

Final Thoughts

There are options to buy a home with no down payment, but they have eligibility requirements. If you don’t qualify, you can look into low down payments loans in conjunction with down payment assistance programs and/or other loans. Whatever route you go, do your research to ensure you make the best decision for you.