Unlocking Homeownership: The Truth About 5% Down Conventional Loans
Are you among the many aspiring homeowners who have been told that you need a whopping 20% down payment to buy your dream home? If so, you're not alone. The myth of the 20% down payment has been circulating for years, leaving potential buyers feeling discouraged and stuck in the rent cycle.
But here's the good news: you don't need to wait until you have 20% saved up. In fact, a 5% down payment through a conventional loan could be your key to homeownership. Let's dive in and explore why this may be the right path for you.
Rising Home Prices: A Dilemma for Aspiring Homeowners
Before we get into the details of 5% down payment conventional loans, let's talk about the elephant in the room: rising home prices. Over the past 40 years, home prices in the United States have risen 535%. Except for a few periods in history, home prices rise year after year.
This might make you wonder if you'll ever catch up, but here's a reassuring fact – the appreciation of home values can work in your favor when you opt for a 5% down payment.
Consider this scenario: You're currently renting and diligently saving up for a 20% down payment on a $300,000 house. If home prices continue to rise at a rate of around 3% per year, that $300,000 home would cost $318,000 in two years. That means you need to save an additional $3,600 (an extra $150 per month) just to keep up.
Here’s a shocker: Mortgage insurance on that house with 5% down would only be $125 per month for a 740-credit-score buyer, says MGIC. This is less than the extra $150 you’d have to save just to keep up with home prices.
By taking advantage of a 5% down payment, you can secure your home now, potentially saving thousands in the long run.
The Benefits of a 5% Down Payment Conventional Loan
Let's dive deeper into why a 5% down payment is a sensible choice:
1. Accessible homeownership: With a conventional loan and a 5% down payment, you can unlock the door to homeownership without depleting your savings. This accessibility allows you to stop pouring money into rent and start building equity in your own home.
2. Faster entry into the housing market: The housing market is competitive, and waiting for that elusive 20% down payment can mean missing out on a suitable home. Secure a property before prices spiral even higher.
3. Leverage home appreciation: Rising home prices and inflation become your friend, not your enemy. Enjoy the appreciation of your property's value while your mortgage payment stays constant.
4. Investment Potential: Real estate has historically been a smart investment. By owning a home, you not only gain a place to live but also a potential source of future financial growth.
Requirements for a 5% Down Payment Conventional Loan
You might think that getting a home loan at less than 20% is too difficult. However, requirements are not that much more stringent then if you were making a large down payment.
The “Conventional 95” as it’s sometimes called are available even to those without a perfect homebuyer profile.
1. Private mortgage insurance (PMI): You’ll need private mortgage insurance with a 5% down payment. The cost for a $300,000 home loan can vary from $95 per month for a 760-credit-score buyer all the way up to $355 per month for someone with a 620 score. Homebuyers with lower credit should see if an FHA loan offers a lower payment.
2. Credit score: While you don't need a perfect credit score, a higher score will help you secure better terms. Typically, a score of 620 or higher is required for conventional loans, but keep in mind mortgage insurance gets expensive with a lower score.
3. First-time buyer considerations: Fannie Mae recently unveiled lower mortgage rates for moderate-income first-time buyers. You don’t have to be a first-time buyer unless you’re putting down 3% and using certain conventional programs.
4. Homeownership education: While a homeownership course isn’t typically required when putting 5% down, it’s a good idea if you’ve never owned before.
5. Income and employment verification: Lenders will assess your income and job stability to ensure you can meet your monthly mortgage payments. Typically about 36% of your gross income can go toward your full housing payment including taxes, insurance, and HOA dues. About 45% of your gross income can go toward housing plus all other debts. Income limits don’t apply for 5% down conventional loans.
6. Property type restrictions: Not all properties are eligible for conventional loans. Most condos and single-family homes are eligible. You must make a larger down payment to buy a 2-4 unit property.
7. Occupancy requirements: You'll need to live in the property as your primary residence for at least the first 12 months.
Comparing 5% Down Payment and 3% Down Payment Conventional Loans
Conventional loans with 3% down are also available. On a $300,000 home, you’ll need $6,000 less in cash for 3% versus 5%. Here’s what to know.
1. Impact on monthly mortgage payments: A lower down payment results in a higher loan amount and monthly mortgage payments. On a $300,000 home, paying 5% down reduces the principal and interest payment by about $40 per month versus 3% down.
2. PMI Comparison: Both 3% and 5% down payment loans require private mortgage insurance (PMI). PMI protects the lender in case you default on your loan. For a $300,000 home, PMI would be an additional $41 per month for someone with a 740 credit score, says MGIC. For both loans, you can request cancelation of PMI after two years, if you have 25% equity. When you reach 20% equity, you can refinance out of PMI.
3. Qualification Criteria: Qualifying for a 3% down payment loan can be harder than for 5% down. Expect to need better credit and income. Note that there are income and first-time buyer requirements for many 3% down conventional loans.
Tips for Successful Homebuying with a 5% Down Payment
Empowering yourself with knowledge and preparation is key to a successful homebuying journey:
1. Careful budgeting: If you have good credit, you can be approved for a higher payment than you’re comfortable paying. Go into homebuying with a budget-based payment level in mind. Then have your lender back into a home price based on that payment.
3. Exploring down payment assistance: Government organizations, non-profits, and even some lenders offer down payment assistance. These programs can make homeownership even more accessible.
4. Maintaining a good credit profile: Continue to monitor and improve your credit score. Also know that most free credit scores you find online do not use the same scoring model that lenders use. This means your free score might be inflated. Make sure you’re looking at FICO 5 scoring model. Sometimes credit cards and banks offer this score for free.
Is a 5% Down Conventional Loan For You?
It’s true that saving 5% down is no small feat in this housing market, where the average U.S. home price is well north of $400,000.
However, it’s more realistic than trying to save 20% and gives renters hope of owning someday. The 5% down payment conventional loan option might be that motivation for you.
Tim Lucas spent 11 years in the mortgage industry and now leverages that real-world knowledge to give consumers reliable, actionable advice. Tim has been featured in national publications such as Time, U.S. News, MSN, The Mortgage Reports, My Mortgage Insider, and more.