Down payments are a big hurdle for many home buyers. Monthly mortgage costs are affordable but down payments are a hurdle. The good news is that there are ways around down payment roadblocks, you don’t have to be a victim of old-fashioned down payment requirements.

The 20% standard

Down payments have been a barrier to homeownership for decades. The problem is that lenders want you to borrow with 20% down. That’s a big number but it makes lenders happy. They think if things go wrong the property can be sold at discount for at least enough to pay back their mortgage. What’s a safe discount? Twenty percent.

It sounds good in theory but there are several problems.

First, 20% down is a huge number. The typical home sold for $271,300 in November according to the National Association of Realtors (NAR). Twenty percent down is $54,260. Closing costs are extra. Not a lot of people can afford such a cash expense.

Second, the old theory may be wrong. A big down payment may not be necessary to protect lender interests!

A 2014 study by the Urban Institute (UI) found that borrowers with down payments between 3% and 5% had the same default rate as those who put down between 5% and 10%. Not higher. Not lower. The same! Borrower credit – not down payment size – was the key risk indicator according to UI.

Today there are a number of solid mortgage options with little or nothing down. The trick? Using insurance coverage and loan guarantees in place of big down payments. Here are some examples.

FHA mortgages (3.5% down)

Begun in 1934, the FHA now backs mortgages worth more than $1.3 trillion. It’s the go-to financing option for millions of homeowners, the place to start, especially for first-time borrowers.

If your credit score is 580 or above you can borrow under the FHA program with 3.5% down. For those with scores between 500 and 579 the down payment requirement increases to 10%. While it sounds good in theory, in practice the reality is that few mortgages are insured with ultra-low credit scores. Just 1.04% of the FHA-backed mortgages originated in fiscal 2019 went to borrowers with credit scores below 579.

The FHA is an insurance program. Borrowers pay an upfront mortgage insurance premium (the up-front MIP) equal to 1.75% of the loan amount. This cost does not have to be a cash expense, it can be added to the loan amount.

There is also an annual mortgage insurance premium (the annual MIP) equal to .85% of the loan amount for most borrowers. This is added to the monthly mortgage payment.

VA mortgages (nothing down)

The VA mortgage program is designed as a loan guarantee for those with qualified military service. It allows vets to buy with nothing down.

The program has been changed for 2020 in two important ways. Under the Blue Water Navy Vietnam Veterans Act, an old rule limiting the amount a vet could borrow has been replaced with a new system that allows larger loans with nothing down. This should be very helpful for financially-qualified vets living in high-cost metro areas.

With VA financing borrowers pay an up-front funding fee. It’s a “funding fee” because the VA program is a guarantee plan and not a form of insurance. The funding fee varies in size according to the amount down and whether this is a first or second use of the program.

Under the old system there were also different funding fees depending on whether the borrower was someone on active duty or in the Reserves and National Guard. Now, however, under the new system all qualified borrowers pay the same fees regardless of their status. As an example, a vet using the program for the first time will have a 2.3% funding fee, an amount which can be added to loan balance.

The VA program is a reward for military service. For that reason the funding fee is waived in certain cases. For instance, there’s no fee for an individual who has been awarded the Purple Heart.

The 3 percenters

The Fannie Mae HomeReady program and the Freddie Mac Home Possible program both allow financing with just 3% down. With a smaller down payment requirement they can be seen as competition for the FHA program.

Do-it-yourself financing with little down

The usual rule with real estate financing is that the borrower must put up all down payment money. For instance, if an owner offers cash to a buyer – a so-called “seller contribution – that’s acceptable within limits for most loan programs. Such money can be used to pay closing costs and for other expenses. However, the cash cannot be used to pay some or all of the down payment. That’s a buyer obligation.

This does not mean the cash-from-the-buyer requirement is absolute. There are exceptions that can help cut down payment costs.

First, gifts from friends, family, employers, unions, a “close friend” (per the FHA), a government agency, or a charity are okay for most loan programs. The donor must provide a letter stating that the money is a gift, that no repayment or interest is required.

Second, there are thousands of down payment assistance programs. You can quickly search for programs in your community at DownPaymentResource.com. Depending on where you live, several programs are likely to be available – in high-cost areas some may be available even for households with six-figure household incomes.

In the end it turns out that the down payment requirement is neither absolute nor as large as it seems. There are exceptions. For down payment details and specifics speak with mortgage loan officers for further information.