It might be better to make a down payment
BY JUSTIN PRITCHARD Updated November 17, 2021
Buying a home with no down payment helps you avoid one of the most difficult aspects of home ownership: the down payment. It’s hard to save a substantial amount of money, and it’s scary to put it all into a home when you might need that money for other needs.
To cater to borrowers with limited cash, some lenders offer mortgage loans that require no money down. But it’s essential to understand the pros and cons of these loans before you borrow.
No-money-down loans are available through the federal government as well as through private lenders.
Buying a home without putting money down can free up cash and may let you buy your home sooner.
However, you'll wind up financing more and paying more interest than you would if you made a down payment.
How to Buy With No Money Down
If you go this route, government loan programs might be your best option. When the U.S. government guarantees lenders against loss, lenders become more willing to approve loans with no down payment. But you still need to qualify for those loans. If you don't qualify for any reason, conventional loans may be an alternative, or you may have to at least make a small down payment on your home.
VA loans are available through the U.S. Department of Veterans Affairs (VA). Servicemembers, veterans, and eligible spouses can buy a home with 0% down. Those loans have no monthly mortgage insurance premiums, so you won’t need to add mortgage insurance to your monthly payment. However, when you buy with zero down, your payments will be relatively high (because of the large loan size). Numerous lenders in the U.S. can provide these loans, so speak with a mortgage broker or financial institution to apply.
TIPS: Lenders compete for your business, so compare offers from several different sources. Each lender may have different interest rates and closing costs.
USDA loans are backed by the U.S. Department of Agriculture (USDA) and are designed to promote home ownership in rural areas. Those loans are only available to borrowers with low-to-moderate income. Still, you can typically earn as much as 115% of your area’s median family income to qualify for the loan. As with VA loans, lenders need to participate in the USDA program, but there are plenty of mortgage brokers and banks to choose from. Get offers from multiple lenders and compare costs before you decide.
No Money Down Loans: Other Sources
If you don’t qualify for a VA or USDA loan, you may be able to buy with no money down using other sources (or you may just need to make a small down payment). In years past, it was easier to buy with no down payment. After the mortgage crisis, those loans are not as plentiful.
Grants and Assistance
Down payment grants and assistance can help you effectively buy with little or no money down.3 However, you might need to wait for a loan to be forgiven or for a tax credit to recoup down payment funds. Technically, somebody is making a down payment, but it might not be you. Search for local organizations that you may qualify for, and ask a local Department of Housing and Urban Development (HUD) representative for any resources available. Some first time homebuyer programs may also be helpful. These programs can be hard to find, and they may have strict qualification requirements. That said, if you are the right fit for an organization, you may be able to get the help you need.
Piggyback loans, sometimes known as 80/20 loans, allow you to buy using two loans instead of a large down payment.4 Before the financial crisis, this strategy was popular. Now, you’ll need the right credit and income profile to qualify. To use this approach, you’d get a first mortgage for 80% of the home’s value (giving you an 80% loan to value ratio for that portion, which means you would not have to pay private mortgage insurance). The remaining 20% comes from a second mortgage that you get at the same time as your first mortgage.
The second loan typically has a higher interest rate, so it may be smart to pay that loan off quickly. Check with local banks and credit unions to see if they offer 80/20 loans and learn about the requirements.
Private lenders may be willing to lend you 100% of a home’s purchase price. These may or may not be professional lenders. In many cases, those loans come from family members who just want to help out (they are not in the business of lending). If you go that route, use a written agreement so that everybody understands the details of your arrangement.
Consult with a local attorney, a real estate expert, and an accountant before signing the agreement. It’s crucial that you follow all applicable laws to prevent problems, and you might be able to get tax or other benefits when you structure the deal properly.
IMPORTANT: If you’re fortunate enough to have somebody willing to lend you money, it can be a win-win situation. But communication is critical—everybody needs to know what they’re getting into.
It May Be Best to Make a Down Payment
The appeal of buying with no money down is obvious:
You don’t need a large sum of money
You can use your savings for furnishings and upgrades
You can probably buy sooner than later.
But there are several drawbacks to borrowing the entire purchase amount.
Large Monthly Payments
The bigger your loan, the higher your payments will be, and you’ll be stuck with that payment for the life of your loan. To see how the numbers work, calculate the payments on any loan you’re considering. Try using larger and smaller loan amounts (a down payment reduces the loan amount) to see how much things change. When you’re stuck with a large mortgage payment, you have fewer options in the future. Any injuries, job changes, or other surprises may be harder to adapt to.
High Interest Costs
Borrowing 100% of a home’s value increases the overall cost of your home. You might not need to write a check today, but you’ll pay more interest on your loan than you would have paid with a sizable down payment. That difference in interest can amount to tens of thousands of dollars over the life of your loan. To see some of those numbers, review loan amortization charts with different loan balances.
Private Mortgage Insurance (PMI)
When you borrow more than 80% of your home’s value, you generally need to pay PMI, which protects your lender.5 The only benefit you get out of that payment is the opportunity to buy with no money down (including the pros and cons discussed here). That expense can add thousands or more to your total lifetime cost, and it further increases your monthly payment.
Home Price Declines
Ideally, your home will gain value over time. But that doesn’t always happen—homes lose value, and you might be forced to sell at a loss. If that occurs, you may owe more on the home than it is worth. To get out of your loan, you’ll need to make a substantial payment to your lender, and that’s never a welcome event.
WARNING: You’re taking a significant risk when you buy with no money down. Your income needs to stay the same or increase, and your home needs to increase in value—which doesn’t always happen. We all believe things will go well, but sometimes life brings surprises.