Each mortgage program has its own minimum down payment requirement. For example, FHA loans require at least 3.5% down. However, there are some cases when you must put down more. The same is true for many other loan programs available today. If you don’t meet their minimum requirements, you may need more skin in the game in order to qualify for the program. Here we’ll discuss these situations and what to do.
FHA Loans
FHA loans are notorious for their low down payment requirements. With as little as 3.5% down, you can secure a great loan program. However, there’s a catch. You can only get away with such a small down payment if you have a credit score above 580. If you have a score between 500 and 579, you must put at least 10% down on the home. This helps the lender make up for the risk your credit score creates.
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This isn’t to say that borrowers with a 579 credit score are going to default on their loan. But, your credit score is a reflection of your financial responsibility. It plays a large role in your eligibility for a loan. A lower credit score often means you defaulted on loans or overextended your credit. Both situations cause problems for lenders, which is why they require the higher down payment.
Conventional Loans
Conventional loans are those owned by Fannie Mae and Freddie Mac. Typically, these programs require a minimum down payment of 3%. However, this is only if the home is owner-occupied. If you purchase a non-owner occupied home, you may have to put more money down on the home. Only single-family homes with a fixed rate mortgage qualify for the 3% down payment.
Purchasing a single-family home with an adjustable rate mortgage requires a down payment of 10%. This gives the lender a little more insurance against default. Because the adjustable rate mortgage can be riskier than a fixed rate, the lender wants to make some of the money upfront. This way if you default on the loan, the lender made a little bit back on the deal. This isn’t to say everyone with an ARM will default. The risk is higher though, once the rate starts adjusting.
If you purchase a second home, such as a vacation home, you’ll need to put down at least 10% for a fixed rate mortgage. If you opt for the ARM, you’ll need 20% down on the home. Second homes are usually riskier than the primary residence. If you got into a financial bind, chances are you’d pay for your primary residence. You may let your second home go if it came down to it. That’s not where you sleep every night, so it’s not as big of a deal to you.
Investment properties require an even larger down payment. Borrowers with a fixed rate must put down 15% and those with an ARM must put down 25%. Investment properties often pose an even larger risk for lenders because the borrower must rely on income from another party. Renters, even with a lease, can default on their rent. If this causes you to default on your mortgage, it puts the lender at risk for a loss.
VA Loans
VA loans are rare because they don’t require a down payment. However, there is an exception to the rule. If the value of the home you purchase doesn’t meet or exceed the purchase price, you’ll need to make up the difference. For example, a home you want to buy appraises at $150,000. However, you agreed to buy it for $175,000. You would have to come up with the $25,000 difference. This is the only way the lender would allow you to have the loan.
What Does the Down Payment Do?
The down payment on the loan helps the lender make money upfront. Aside from the closing costs, lenders make money off the interest on your loan. What happens if you don’t make your payments, though? The lender doesn’t make any money. This is the reason they often charge higher down payments. Any aspect that makes your loan risky causes the lender to raise the down payment requirements.
Can you Avoid Putting More Down?
There is a way to prevent the requirement for a large down payment. You can provide the lender with compensating factors. These are factors that make your loan look less risky. For example, high credit scores and low debt ratios go far with lenders. This shows them financial responsibility. On the other hand, low credit scores and high debt ratios can work against you. They can make a lender leery of providing you with a loan.
Sometimes compensating factors can help minimize the amount of money you must put down on the home. The lender looks at the big picture. They don’t look at each individual factor. Instead, they look at how risky your entire loan file is. If you can make one part of your application look attractive, it can decrease the unattractiveness of another part.
Can you ever get around the down payment requirements? It’s not likely. A lender may bend the rules if you have certain compensating factors. Usually, though, they stand by the written requirements. If you don’t meet the specific credit score or you purchase a home for purposes other than living in it, you will make a higher down payment. Consider it a way to gain equity in your home right away. It’s not money you’ll never see again. Hopefully, you’ll have a good return on your investment and see the money again. Until then, consider it a long-term investment!