No, You Don't Need A 20% Downpayment to Buy A Home
The idea that a 20% downpayment is required to purchase a home is a common misconception. In fact, most home purchasers buy with far less down — the average is about 11% down.
Yes, is it often ideal to have a 20% downpayment. Why? The more you put down, the lower your mortgage will be — so 20% down versus 10% down means your mortgage payment each month will be less. Similarly, if you do 50% down versus 20% down; but, then again, there is a point at which putting too much down really doesn't make sense at all — buying with a higher downpayment means more cash being tied up in your home. Ultimately, you have to determine what makes sense for your personal financial situation.
The other reason folks sometimes aim for 20% down is that the lender won't charge you PMI, also known as private mortgage insurance. PMI protects the lender from losing money if the borrower ends up in foreclosure — and at less than 20% down, lenders consider the buyer at an increased risk of foreclosing, hence the additional fee. PMI rates vary, but tend to range between 0.3% and 1.2% of the loan amount on an annual basis. This fee is akin to what you might pay in a monthly homeowners or condo fee.
An example: With a downpayment of 10% and $360K loan, a 0.41% PMI amounts to about $120 per month, or $1,440 over the course of the whole year. Compare that to waiting until you have another 10% to put down — another $36K — and you can see how there could be benefits to moving forward with a lower downpayment. Note also that unless you have an FHA loan, once you have 20% equity in the home you can ask the lender to cancel your PMI. At 78% equity, it must automatically be removed. There are other ways to avoid PMI, and that's with a higher interest rate and a piggyback loan.
If you don't need 20% down, what sort of downpayment do you need?
Eligible veterans can benefit from a 0% down VA loan, or from Navy Federal's 0% down alternative loan. You can also try the NACA program, which is a 0% down, no closing cost program. This can be a fantastic option, though there are some hurdles within this process and if you were to begin their program today, you're likely a year out from closing on your new home. HPAP is a loan payment assistance program for low and moderate-income residents in the District; however, after having done a handful of loans with them, I can't in good conscience recommend them. The government-backed FHA loan requires just 3.5% down. Finally, there are plenty of lenders offering 3%, 5%, and 10% options and everything in between.
A few critical things to remember as you seek out your pre-approvals (which you must do before you start your house hunt):
1. Get-pre-approved by at least two reputable and local lenders. They will be happy to compete for your business. An small online lender no one has ever heard of who claims to have the best deals is almost always a recipe for disaster. Non-local? I don't think we've ever had a non-local lender who didn't have at least one major mistake as they took our buyers through the loan process — this includes mis-information, closing delays, and inaccurate estimates.
Go with someone local who understands the local market and customs, who is also going to give you a great deal and excellent service — hopefully, you've chosen a trustworthy, experienced agent and he or she will have recommendations on great local lenders.
2. Remember that your down-payment is only one portion of the cash you need to have on-hand for buying a home. Here's what else to expect:
3. Cash to cover closing costs — these are transactional fees associated with purchasing a home. These includes taxes, lender fees, and pre-paid items like mortgage insurance. In DC and Maryland, closing costs amount to about 3% of the sales price and in Virginia they total about 2.5% of the sales price. In other words, if you purchased a $500K property in DC you'd likely need about $15K in cash for closing costs. Depending on the micro-market in which you decide to purchase, the inventory and the season, you might be able to get some or all of your closing costs covered by the seller. We can discuss the opportunity for this during your buyer consultation.
4. The fee for a home inspection will tend to start at $500, and you'll want another $500 or so on hand for the appraisal, which is paid out of pocket before you close. Any other inspections will also need to be paid by the buyer before closing — these include termite inspection ($35), radon test ($170-$200), etc. And, of course, you'll want to have a nice little cushion for any issues that might come up in your first couple years as a homeowner.