How to buy a home with a small down payment

Don’t think you can purchase a home because you don’t have the cash on hand for a 20 percent down payment? Think again. It's now possible for people to get a mortgage with a small down payment - or even no down payment at all.

"Yes. You can buy a home without a large down payment," says Esther Phillips, senior vice president at Key Mortgage Services, a full service mortgage lender in Illinois. "But it is imperative that you work with a knowledgeable mortgage loan originator in determining what is the right loan program and loan structure for you."

Ready to find out how you can buy a house without that 20 percent down payment? One of these loan options might just be right for you.

Option #1 - FHA Loan

According to the U.S. Department of Housing and Urban Development's website, FHA (Federal Housing Administration) loans have been helping people become homeowners since 1934. Currently, homeowners may get loans with as little as 3.5 percent down.

"Low-income families may find this an easier way to purchase that first home," says Dan Hapner, director of mortgage sales of Meriwest Mortgage (a wholly owned subsidiary of Meriwest Credit Union). According to Hapner, the FHA loan typically has lower interest rates than conventional loans, and an FHA loan also has looser underwriting guidelines.

For example, "[a]n FHA loan can accept a low FICO credit score of 580, as opposed to the 680 required for a conventional loan," Hapner says. You can also make your down payment using borrowed or gift money, something which many conventional loans don't allow.

"This means the borrower does not need any of their own funds to purchase a home," says Phillips. "However, the loan requires both a one-time insurance premium to be paid (which can be financed into the loan amount), and monthly mortgage insurance for the life of the loan," Phillips adds. "This monthly amount is typically more expensive than private mortgage insurance, which is used for conventional loans."

Option #2 - Conventional 97 Loan

As you might be able to guess by the name, the Conventional 97 loan allows you to finance 97 percent of the purchase price of a home, leaving you with just a 3 percent down payment.

"That product is very interesting," says Al Hensling, a mortgage broker with over 30 years of experience. "It's really a great option for well-qualified borrowers without a lot of money for a down payment."

Unlike the FHA loan, however, the underwriting standards for the Conventional 97 loan are much tougher. For example, gift funds are not allowed for the down payment, and you'll need to demonstrate verifiable income and a good credit history.

How good of a credit score might you need? "Higher than average," Phillips says. "Usually 740 or greater."

However, because of these tougher standards, lenders aren’t risking as much when loaning you money and as a result, may not charge you as much on mortgage insurance.

But, even though you may pay less overall for mortgage insurance, you may be required to pay mortgage insurance for the life of your loan (which is also the case with an FHA loan), Hensling says. And although it may be possible in some cases to get rid of mortgage insurance, it won't be easy.

"If one's home has increased in value and they wish to remove PMI, they have many hoops to jump through (paperwork and appraisal) before that will be granted if they are not refinancing the original loan," he says.

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Option #3 - Fannie Mae/Freddie Mac

Fannie Mae and Freddie Mac are the nation's two federally-chartered mortgage finance companies. Although they don't give loans directly to homebuyers, they purchase mortgage loans from lenders to ensure that lenders have a ready supply of funds on-hand to continue giving mortgage loans to borrowers, according to their respective websites.

Fannie and Freddie also have some great programs that lenders can utilize to help borrowers get into homes without a large down payment.

"Freddie Mac Home Possible and Fannie Mae My Community Products allow for lower down payments (5 percent and 3 percent, respectively), lower private mortgage insurance premiums, and allow for funds to be gifted," says Phillips.

The program that is right for you will depend on your specific circumstances. While both Freddie and Fannie are quasi-governmental agencies, they aren't interchangeable, so make sure to do your research to help you narrow down your options.

Option #4 - The Home Path Program

On a related note, Fannie Mae has a program called the Home Path program - and for the right buyer looking at the right property, this could be a great fit.

"This is a program that has been put into place by Fannie Mae to help sell off properties that Fannie has in their portfolio," Hensling explains. "The program allows buyers to buy with low down payments and no mortgage insurance." The catch, though, is that the program is property specific.

That means the property you're hoping to buy needs to be one of the properties that Fannie Mae owns - typically a home that has been foreclosed upon. But, if you do find a home that qualifies, the Home Path Program might make it possible to buy a home with less than 20 percent down, according to Hensling.

"Even individuals who might buy property for investment instead of a residence can buy with as little as 10 percent down, as long as they can qualify," Hensling says.

Option #5 - State Specific Programs

"Many states have housing authorities that, through bond sales, fund loan programs for first-time homebuyers," says Phillips. While the details of the programs will vary state by state, Phillips provides one example of an excellent state-run program from Illinois.

"The Illinois Housing Development Authority (IHDA) provides first-time homebuyers financing with as little as 1 percent [down] or $1,000 of the borrower's own funds," he explains. The way this works is that the IHDA gives the borrower a mortgage loan for the amount of the home, and then the borrower takes out a second mortgage loan at 0 percent interest for the down payment and closing costs.

In addition to helping a borrower land a mortgage with as little as 1 percent down, the IHDA also offers specialty financing to veterans or active military that provides up to $10,000 in down payment assistance.

Option #6 - VA Loan

There's a great program out there for those dedicated men and women who serve in the armed forces who are now looking to buy a home.

"For qualified veterans, they can purchase a home with a 0 percent down payment," says Hensling. "That means 100 percent of the purchase price of the home is available for them to borrow."

Hensling goes on to explain that "[t]hey have very low interest rates, and require no mortgage insurance. They also have very relaxed underwriting standards." It's a special perk, reserved for veterans who - by their service - have earned it. So if you've served, it might benefit you to check out whether or not a VA loan might be right for you.