Common Down Payment Myths: What is the Truth?
Buying a home is a huge investment with many important financial decisions to be made. Homebuyers, especially first-timers, are often overwhelmed with the process and often worry about having to save a lot of money before applying for a mortgage. To help smooth the learning curve, here are five common misconceptions about down payments.
1. Do Buyers Need to Put 20% Down?
The term “20% down” is a common phrase associated with buying a house. In reality, most first-time buyers only put down six or seven percent as a down payment. While conventional lenders will still approve a mortgage with less than 20% down, it's important to understand they do require buyers to obtain private mortgage insurance (PMI). PMI is designed to protect the lender's interest in the event the buyer defaults.
However, other options for homebuyers that don't require 20% down include:
- FHA loans, which are backed by the U.S. Federal Housing Administration, require just 3.5% down.
- VA loans, which are backed by the U.S. Veterans Administration, typically require little to no down payment.
2. Does Buying a Home Require an Excellent Credit Score?
Buyers often believe if their credit score is on the low side, they can't get mortgage approval. This is a fallacy. While it's true an excellent credit score will open up more loan options with favorable terms, it doesn't mean a lower credit score makes buying a house out of the question. A “good” credit score is in the 670-739 range, and a 580-669 score is considered “fair.” Individuals with these scores, and even lower scores, still have several options.
- FHA Loans require a minimum 500 credit score (10% down payment) or 580 (3.5% down payment)
- VA Loans are generally approved with credit scores ranging between 580-620 and up
- USDA Loans require a minimum credit score of 640 (specific location criteria must be met to qualify)
- Freddie Mac Home Possible and Fannie Mae HomeReady Loans require a 620 minimum credit score (these are reserved for low to moderate-income borrowers)
Lenders offering conventional loans typically require a minimum of a 620 credit score. It's a good idea for buyers struggling with credit scores to explore all of the options they qualify for to ensure they get the best mortgage terms.
3. Is Getting Prequalified for a Mortgage Equal to Getting Preapproved?
People often confuse the terms “prequalified” and “preapproved.” Buyers who obtain prequalification don't necessarily get the loan; all it means is the lender offered an estimate of how much can be borrowed. Meanwhile, preapproved means the lender has already vetted the buyer and will issue a loan for the specified maximum amount. Prequalified doesn't take into account how much down payment is being made since it only offers an estimate. On the other hand, people who obtain a preapproval letter from a lender can buy a home immediately.
4. Is Down Payment the Only Money Needed at Closing?
Many buyers don't realize there are additional costs associated with buying a house, most notably closing costs. Closing costs are separate from the amount used as a down payment for the home. While buyers may elect to roll any closing costs they've agreed to pay into their mortgage, it isn't mandatory. Closing costs represent about 2% to 5% of a mortgage amount, but paying closing costs up front means buyers can take out a smaller mortgage to avoid paying interest rates on a larger loan. Paying closing costs with cash brings the overall purchase price down.
5. Is Down Payment Help Only for First-Time Buyers?
While many assistance programs are geared toward first-time buyers, it's not all of them. For instance, people who haven't owned a home within the previous three years are considered first-time buyers by the U.S. Department of Housing and Urban Development (HUD). Buyers should always research and check to see if they are eligible for assistance.
Sorting through the finances of buying a home can seem complicated. Understanding the different loan options and myths linked with the down payment portion of the loan can help people make the best decision for themselves.