Buy Your First Home With Little Money Down Using These Strategies
The thought of buying your first home can be pretty daunting, not to mention the huge 20% down payment you will need to secure a loan. It is never too early to begin planning for what will likely be your biggest investment. The most common way to buy a house is to save up for a 20% down payment and take out a mortgage to cover the rest, this is referred to as conventional financing; but what if there were other ways to fund your first home — without having to drain your savings? I want to share with you a few unconventional ways to finance the purchase of your first home.
This is a list of just a few loans and strategies we’ll go over that don’t require a 20% down payment:
FHA Loan
203K Loan
80/20 Mortgage
Seller Financing
VA Loan
USDA Loan
Let’s begin with the simple FHA loan
FHA stands for the Federal Housing Administration, it was created as part of the National Housing Act of 1934 in an effort to increase homeownership in America. The FHA insures the mortgages issued by lenders which allows them to offer better loan terms such as lower down payments, and loan to individuals with lower credit scores who typically wouldn’t qualify for conventional loans.
With an FHA-insured loan, homebuyers can put as little as 3.5% down. This is a great option for first-time homebuyers since the requirements to get approved for an FHA loan are one of the the easiest to meet. Lets review what some of the requirements are to get an FHA loan:
Credit score, minimum 500
Debt to income ratio less than 50%, based on monthly gross income
Down payment of at least 3.5%
The property type can range from a single family home up to a 4-unit apartment building
Must live in the property for at least one year
These are just the basic requirements to get approved for an FHA loan, although if you meet these requirements you are in a good position to satisfy any other requirements. Saving up for that 3.5% down payment will likely be your biggest challenge when using an FHA loan, also keep in mind that you will need to cover any closing costs.
I’m a big fan of the FHA loan for its minimal down payment, although this does come at a price. When you use an FHA loan with less than 10% down, you will be locked into paying a mortgage insurance that lasts the full term of the loan. One option to get rid of the mortgage insurance is to do a hard refinance once you’ve built up enough equity to not require mortgage insurance, which is typically 20%.
FHA 203K Loan
An FHA 203K loan is similar to a standard FHA loan, but includes additional funding for renovations. The requirements for an FHA 203K loan are similar to a standard FHA loan, however the property itself must be eligible for this type of loan by being older, outdated, or in need of repairs. Qualifying properties for this loan can seem subjective because improving a home’s functionality or attractiveness can qualify a property for a 203K loan. Additionally, any projects funded by a 203K loan must receive multiple contractor bids, be done by a licensed contractor, and be approved by an FHA appraiser who will handle contractor payment.
This may seem like a lot of hoops to jump through, however when the renovations are complete you’ll have a brand new kitchen, bathroom, etc. to enjoy in your new home that you only used 3.5% down to purchase while enjoying the low interest rates offered by 203K loans. Another bonus of purchasing a 203k home is that not many people are in the market for a house that needs repairs. Use this to your advantage to negotiate a great price for the home.
80/20 Mortgage
80/20 mortgages are basically two separate mortgages, one for 80% of the property purchase price and the other for 20%. This brilliant strategy divvies up the mortgages so that you receive 100% financing for the home while avoiding paying private mortgage insurance, which is required for mortgages over 80% of the purchase price. This works by applying for a conventional 80% primary mortgage and then applying for a home equity line of credit (HELOC) for the other 20%. This means twice as much paperwork and two separate monthly mortgage payments, of course. Not all banks will provide 80/20 financing, and you may have to go to a separate bank for the HELOC.
This type of financing is typically reserved for those with good credit, as it is considered risky for the lenders who hold secondary lien position. It doesn’t hurt to ask your mortgage loan officer if you are eligible for an 80/20 mortgage. The benefits of an 80/20 mortgage include avoiding private mortgage insurance, 100% financing (no money down), better mortgage rates by using the HELOC to reduce the primary mortgage amount. Keep in mind that HELOCs are variable loans and rates can go up, so be careful not to become over-leveraged.
Seller Financing
Did you know that roughly 1/3 of all houses in America are owned free and clear? This means that the mortgages have been paid off and there is 100% equity in the house. Like the other financing options mentioned, there are no requirements to be eligible for seller financing; this comes down to how good you are at negotiating, and takes a little finesse to pull off successfully. If the seller doesn’t immediately need the money from the sale of their house, seller financing can be a great option for all parties involved. While you get to leverage their money to buy yourself a house, they are able to earn interest on their money while receiving monthly payments.
There is not much more to seller financing, and again — it all comes down to your negotiation skills, as you can ask the seller to carry 20, 80, or even 100% of the note, it’s up to you! Many people don’t even consider this as an option because they are unaware that it is possible, or they may be too shy to ask.
Pro tip: after you have negotiated a price for the property, just ask the seller what they plan to do with the money. If they are unsure, this is when you can bring up the option of seller financing.
VA Loan
This loan is exclusively for active duty military, or veterans, and their spouses. A VA loan is a zero down mortgage, insured by the Department of Veterans Affairs (VA). Heres how it works: After applying for eligibility with the VA, they will let you know up to what amount they will insure on the loan. This is similar to getting a pre-approval for any other home loan.
The basic requirements to get a VA loan include having a low debt-to-income ratio with enough income to cover the mortgage, and you have to intend to live in the property you’re purchasing. I have heard of exceptions being made in an instance where somebody used a VA loan to buy a house they were planning to live in, were re-stationed to another military base, and were able to keep the house and rent it out. I don’t recommend doing this intentionally, but it’s nice to know you won’t lose your property if it happens.
For active duty military who are moving around a lot, this is a great option because of the no down payment required. It can be refinanced to a loan with lower rates, and you can use the VA loan multiple times as long as you have paid off or refinanced any existing VA loans.
USDA Loan
If you enjoy a rural lifestyle, this may be the loan for you. USDA, or the U.S. Department of Agriculture, is the same agency that inspects our meat. Like the FHA loan, USDA loans are insured home loans for eligible rural and suburban homebuyers, with a zero down payment required. The purpose of this program is to improve economy and quality of life in rural areas of America. This loan is typically given to low-income applicants and can have interest rates as low as 1%.
The basic requirements for this loan are having an estimated monthly mortgage payment of less than 30% of your monthly gross income, consistent income for the past two years, and a decent credit score. USDA loans are limited though, so you aren’t guaranteed to receive a loan if you qualify, as priority is given to those with the greatest need for this loan.
Financing a home is like an art
There are many ways to do it and you may have to get creative with your strategies. For example, use the 80/20 mortgage strategy but instead of getting a HELOC, ask the seller to carry 20%. While we reviewed six different loans and strategies to buy a house, there are many more options out there and I encourage you to look into them to find the best one for your situation!
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