First-time home buyers face challenges raising money to purchase a new home. Therefore, most people resort to conventional loans to help them obtain a new home.
Conventional loans require a good credit score and a solid down payment. The down payment amount may vary depending on the lender or borrower’s credit information. This article provides detailed information about conventional loan down payment options and requirements.
What is a Conventional Loan?
Conventional loans are loan types that are not insured or backed by government agencies. The money issued to borrowers comes from private lenders. However, the government provides the rules and regulations, thus referred to as conforming loans.
Since the government does not insure conventional loans, lenders provide strict regulations to borrowers compared to federal mortgage loans. In this case, lenders require borrowers to have a higher credit score and a lower debt-to-income ratio.
The minimum down payment provided by most lenders is 3%. People with poor credit ratings will also require a larger down payment to qualify for a conventional loan.
However, conventional loans have several benefits compared to the barriers, especially for people with strong credit profiles. In a recent study by the U.S Census Bureau, 74% of all conventional loans were used as mortgages to purchase new homes in 2021.
What is the Minimum Down Payment for a Conventional loan?
The minimum down payment option is 3%. However, most lenders require borrowers to add a PMI to the monthly mortgage payments if the down payment is less than 20%. This regulation does not deter Americans from applying for loans. Studies show that 75% of first-time home buyers make less than 20% down payment.
Why a 3% Down Payment is a Smart Choice
With the 3% down payment option, most first-time homebuyers qualify for a fixed-rate mortgage of up to $625,000 for single-family homes, condos, and town units. This rate is affordable to most first-time homeowners and allows them to build their home equity. However, you may need to pay for private mortgage insurance until you attain the 20% limit.
Why a 5% Down Payment option is a Smart Choice
A 5% down payment option allows lenders to choose between an adjustable-rate mortgage or the fixed-rate mortgage. With a slightly larger down payment option, it is easy to convince lenders to lower the interest rate. It also helps you avoid spending all the money on a down payment and remain with some for emergencies.
People who have owned a home within the last three years must make a 5% down payment for a conventional loan. The ARM helps you save money in the long run, especially when you sell the home within ten years.
The first 5, 7, or 10 years of an ARM come with a lower introductory fixed interest rate. The introductory interest for ARM is always lower than the rates offered for the traditional fixed-rate mortgage.
Why the 10% Down Payment Option is Best for You
A survey in 2020 found that average first-time home buyers made a down payment of 7%. Therefore, making a 10% down payment has several advantages. A 10% down payment reduces the loan total and the monthly amount you need to pay.
Like the 5% down payment option, making a 10% down payment allows you to choose between a fixed-rate mortgage and adjustable-rate mortgages of up to $548,250 for single homes, condos, and planned unit developments. Since the down payment is less than 20%, borrowers will pay for private mortgage insurance.
If you plan to purchase a home in a costly area such as San Francisco and Hawaii, a 10% down payment and excellent credit profile make you eligible for a jumbo loan at District Lending. Visit the official website to get more information about jumbo loans.
Why a 20% Down Payment is the Best Option
Making a 20% down payment has several benefits. The only challenge most people face is saving enough money to attain 20% of the total property cost. Once you pay the total amount, you may not have money for emergencies or other costs. However, some of the benefits of making a 20% down payment include the following:
It reduces the loan Amount
A larger down payment reduces the total amount you need to borrow. Therefore, the monthly payments will be lower.
It reduces Overall Loan Costs
When you request a lower loan amount, you pay less interest. Lenders calculate the interest from the total loan amount borrowed. A 20% down payment also exempts you from paying private mortgage insurance, which increases monthly payments.
It Provides You With More Equity.
Making a 20% down payment provides you with more equity in your home in case the home prices decline. A smaller down payment puts you at risk of owing more than the home’s worth, especially if the prices decline. When you owe more than the home’s value, selling and refinancing the loan may become challenging.
What to Do if You cannot afford the 20% Down Payment Option
Although making a 20% down payment has several benefits, people still prefer making low down payments. One can choose between different loan options such as:
Conventional loan with Private Mortgage Insurance
The term conventional means that the loan is not part of any government program. Borrowers will need to pay private mortgage insurance when they put a down payment of less than 20%. Most people pay the PMI as a monthly premium added to the monthly installment.
Several lenders provide conventional loans with down payments ranging from 5% to 15%. However, some lenders, such as District Lending, provide conventional mortgage loans with a low down payment of up to 3%.
The Federal Housing Administration Loan
The FHA loans are also available with a 3.5% down payment or higher. They provide a suitable choice for the buyer who wishes to make a smaller down payment. However, people with good credit scores and who can afford a higher down payment of up to 15% may find an FHA loan expensive compared to a conventional loan with PMI.
Special Loan Programs
Certain groups of people qualify for special loan programs that do not require a down payment. These groups include veterans, service members, and rural borrowers. State programs can provide assistance and other special loan options for low-income and middle-income families and civil servants.
How to Determine the Right Down Payment Option
Determine the Total Amount you can Afford
The first step is to determine the amount of money you have upfront for a home purchase. Gather all your recent savings and investment statements to determine an accurate number. When determining how much you can spend, ensure that you spare some amount for emergencies and other purposes such as closing costs.
Most people are tempted to put all their cash into a down payment. This move may be risky since you may encounter unexpected expenses. The best option is to put up an emergency fund with at least three months of living expenses as you plan to move to your new home.
Investing all your money in your home means that it is not available in case of an emergency. Therefore, you may need to go for home equity loans that allow one to borrow against their equity. You must also pay closing costs on loan using the same savings.
Explore Different Loan Options
Determining the right down payment option depends on your financial and personal situation. Knowing how the down payment may affect your loan options and how much you will pay as monthly installments will help you determine the best loan option.
Loan officers at District Lending are willing to help you compare different loan options depending on your situation.
How to Save for Your Down payment
Below are some tips to help you save for your down payment.
Start Saving Immediately
Open a separate account specifically for your down payment funds. This move does not require you to determine how much down payment you need. It helps you keep track of your progress and avoid spending money on other things.
Draft a Plan
Before making your plan, determine your total savings and how much you will need. Calculate the total home price by multiplying it by 5,7, 10, or 15 percent. Add 2-5% as closing costs and compare to the total amount you have. Depending on your monthly expenditure, you can gauge how much you can save every month.
Schedule your Savings
Set up a regular deduction from your total income every month. You can organize with your bank to automatically deposit the amount to the down payment account.
Other Conventional Loan Requirements
Conventional loans are known as conforming loans since they adhere to the standards set by Fannie Mae and Freddie Mac. These government-sponsored agencies play an important role in the mortgage market. Apart from the down payment, other conventional loan requirements include:
Conventional loans come with credit score requirements that vary between lenders. Having a high credit score can help you lower the interest rate. Most conventional loan lenders require you to score 620 to qualify for a conventional loan.
Debt to Income Ratio
Lenders also look at the debt-to-income ratio to determine how much you qualify for. This ratio represents the total monthly debts divided by your gross income. Your DTI should be at least 43%. A low DTI indicates that you can comfortably pay your mortgage in the event of an emergency.
Planning to Buy a House
Acquiring a new home is exciting, but it is one of the major financial decisions one can make. Most people opt for mortgage loans to help acquire a new home. However, some lenders put stringent measures making it difficult for a first-time home buyer to qualify for a loan.
With District Lending, first-time home buyers can easily acquire a new home through the mortgage finance option. It provides borrowers with flexible interest rates with no lender fees. Get a quote by visiting the official website.
Frequently Asked Questions
What Is a Conventional Loan?
A conventional loan is a loan type that is not insured or backed up by the government. One can obtain conventional loans from private lenders such as banks. However, the government provides rules and guidelines, classifying them as conforming loans.
What Is the Minimum Down Payment?
Lenders have different down payment options for people who wish to apply for a mortgage loan. However, the minimum down payment for conventional loans stands at 3%. Depending on their cash reserve and preferences, borrowers can also make up to 20% down payment.
What are the benefits of Making a Larger Down Payment?
Making a larger down payment has several benefits, such as:
- It increases home equity
- It reduces interest rates
- It reduces the total amount payable monthly