You want to start climbing the property ladder. You want to buy your own home. But there’s just one problem: You don’t have the cash for a 20 percent downpayment.
What should you do?
First, let’s assess your current situation: Are you a first-time homebuyer? Or do you currently own a home? If you’re already a homeowner, you might be in a better position than you realize.
You might not have $40,000 laying around in a bank account to make a 20 percent downpayment on a $200,000 home. But you do have equity in your existing home.
When you sell that home, you can use the equity to pay for your next home. The key is to write an offer that’s contingent on the sale of your current home. This is a common contingency, so your real estate agent will easily be able to include it in your contract. And because this type of contingency is so popular, the seller shouldn’t balk (unless you’re in a hyper-competitive market.)
But what if you’re underwater on your mortgage — or a first-time homebuyer? Read on.
#1: Apply for an FHA Loan
The Federal Housing Administration, or FHA, insures loans for qualified first-time homebuyers. These are known as “FHA Loans.”
The FHA itself doesn’t issue the loan. Rather, a financial institution such as a bank or credit union issues the loan, which is then insured by the FHA. This protects the lender from loss. Because the lender carries less risk, they can offer the loan at rock-bottom interest rates.
The result: you get a mortgage loan at a low interest rate with as little as 3.5 percent down.
However, there are two drawbacks or limitations to taking out an FHA loan.
First, you’re only qualified to spend 31 percent of your gross monthly income on all housing-related expenses, including your mortgage, property taxes, insurance, plus any homeowner’s association (HOA) fees. In other words: If you gross $5,000 per month, you can spend no more than $1,550 per month on housing.
Of course, that’s not entirely a “drawback.” Yes, it’s a limitation. But it’s a limit that will prevent you from tackling a mortgage that you can’t afford.
Second, you’ll be required to pay private mortgage insurance, or PMI, until you reach 20 percent equity. The rates vary, but as a rough ballpark, expect to pay an additional $40 – $50 per month on every $100,000 of mortgage that you carry. (This will be lumped into your 31 percent limitation.)
#2: Look to City Programs
Many cities offer downpayment assistance to its residents. For example, a program called Invest Atlanta offers $10,000 – $20,000 in mortgage assistance (in the form of an interest-free second mortgage) to people who buy a home with City of Atlanta limits. Likewise, the City of San Francisco will lend first-time homebuyers up to $200,000 to put towards their downpayment.
Some of these city programs mandate that you must be a first-time homebuyer; others don’t. Some programs are capped at certain income limits; others aren’t. Research the city, county and state programs in your local area to find out the details of what’s in your neighborhood.
#3: Get a VA Loan
Qualified military veterans can obtain a mortgage with zero downpayment, thanks to a program administered by the Department of Veteran’s Affairs.
Like an FHA Loan, a “VA Loan” is a federally-insured loan that’s issued by a traditional financial institution, like a bank. VA Loans are given to veterans who maintain good credit, meet income requirements, and have a “Certificate of Eligibility” through the VA.
These loans don’t require any downpayment, and as an extra bonus, the buyers don’t need to pay PMI, either — making them an even better deal than FHA loans. Furthermore, the VA restricts the amount that the lender can charge for closing costs, which means you’ll have built-in protection from getting ripped-off by ancillary fees.
#4: Apply for a USDA Loan
Not an urban-dweller? You may be able to take out a loan that’s insured by the U.S. Department of Agriculture. These “USDA Loans” are designed to encourage homeownership in rural areas.
To qualify for a USDA loan, your income can’t be more than 115 percent of the median income within the area in which you reside.
Like the VA loan, USDA loans allow you to purchase a home with zero downpayment. However, unlike the VA loan, you will need to pay monthly PMI.
There are two drawbacks. First, the USDA only approves certain houses, which means your pool of potential new dwellings will be limited. If you have your heart set on a specific house, and it’s not USDA-qualified, you won’t be able to use this loan to buy that particular abode.
Secondly, you’ll be limited to spending no more than 29 percent of your gross income on all housing-related costs (including PMI), and no more than 41 percent of your gross income on all of your combined debt payments, including your mortgage, car payments, student loans, and more.
The Bottom Line
Don’t have a 20 percent downpayment? Don’t sweat. Regardless of whether you’re a city-slicker or a country-dweller, a first-time homebuyer or a military veteran, there are plenty of options you can explore.
originally posted on Truila Tips by Paula Pant, March 21, 2014