Reader question: “Can I buy a house with a down payment of only 5%? Is that enough money to put down to qualify for a mortgage loan?”
This is a common question among home buyers and mortgage shoppers. The short answer is yes, a well-qualified borrower can certainly get a mortgage loan with 5% down. That’s enough to satisfy most mortgage lenders these days.
But you will most likely have to pay for private mortgage insurance with a down payment of 5% or less. There are other things to consider as well, when making a down payment of that size. So let’s take a closer look.
Getting a Mortgage Loan with 5% Down
For many borrowers, a 5% down payment is enough to qualify for mortgage loan. In fact, there are several loan programs available today that allow borrowers to make a down payment as low as 3% – or even zero.
So, let’s start by looking at the different mortgage options available for people who want to make a 5% down payment on a house.
- Conventional: A conventional mortgage loan is one that’s not insured or guaranteed by the federal government. It’s a “regular” home loan. The conventional label distinguishes it from the government-backed programs mentioned below, like FHA and VA. Conventional mortgage loans are one option for borrowers who can only make a down payment of 5%. In fact, you could qualify for a conventional loan with a down payment as low as 3%, if you meet all other program requirements.
- FHA: The Federal Housing Administration loan program is a popular financing tool among home buyers, especially those with limited funds for a down payment. The FHA program allows eligible borrowers to buy a house with as little as 3.5% down. You’ll need a credit score of at least 580 to qualify for the program, along with a manageable level of debt. So that’s one option for borrowers seeking a mortgage loan with a down payment of 5% or less.
- VA: If you are an active duty military member or veteran, you’re in luck. The VA loan program allows borrowers to finance 100% of their home purchase. That means you can buy a house with no down payment whatsoever. This program is arguably the best financing option for borrowers who qualify. It’s open to almost all military people, including those who have served in the past.
- USDA: If you’re buying a home in a rural area, and your income falls below a certain threshold, you might qualify for a USDA-backed home loan. This is another government-backed mortgage program that allows borrowers to finance the entire cost of the home, with no down payment.
The VA and USDA loan programs mentioned above are geared toward a specific type of borrower. The FHA and low-down-payment conventional mortgage options, on the other hand, are available to a broader spectrum of borrowers. So keep that in mind, as you consider your options for making a down payment of 5%.
You’ll Probably Have To Pay PMI
To recap, a down payment of 5% is enough to qualify for several different mortgage programs. We covered those programs above.
But it’s important to realize that you will probably have to pay for private mortgage insurance (or the government version of it) if you make a down payment of 5% or less.
Mortgage insurance is typically required whenever a single loan accounts for more than 80% of the home’s appraised value. So, if you buy a house with less than 20% down, you could end up with a loan-to-value (LTV) ratio above 80%. In that scenario, you would probably have to pay for mortgage insurance.
- Conventional loans with down payments of 5% typically require what’s known as private mortgage insurance, or PMI. It’s called “private” because the insurance comes from an insurer within the private sector.
- FHA loans, on the other hand, typically require a mortgage insurance premium that’s imposed by the government. But it’s not called PMI because it does not come a from a private-sector insurance provider.
The key takeaway here is that borrowers who make down payments of 5% or less typically end up with a loan-to-value ratio above 80%. And because of that, they have to pay for mortgage insurance. This added cost gets rolled into the monthly payments.
This doesn’t mean mortgage insurance is bad. It actually makes homeownership available to a much larger group of folks. Without mortgage insurance, the 20% down payment would probably become a standard requirement across the board. And that would keep a lot of would-be home buyers out of the market entirely.
Mortgage insurance is what makes it possible to qualify for a home loan with a 5% down payment. You just have to realize it’s an added cost that will increase the size of your monthly payments.
And speaking of monthly payments, let’s talk about those next.
Less Money Down Brings Larger Monthly Payments
You also want to consider the relationship between the down payment and your monthly mortgage payments. When you make a larger down payment, you are financing a smaller portion of the purchase price. Therefore, you will end up with a lower monthly payment.
On the other hand, putting less money down up front increases the size of the loan (e.g., the amount being financed). This will result in a larger monthly payment, compared to the first scenario above.
You can only afford what you can afford. Putting 20% down on a home purchase might not be an option for you, for budget reasons. You might be limited to a 5% down payment, due to a lack of funds. And that’s okay. We just talked about the fact that 5% down is enough to qualify for several mortgage programs.
You just need to consider the inverse relationship between (A) the amount of money you put down and (B) the size of your monthly mortgage payments. Do the math ahead of time, and choose the path that works best for you.
Your Ability to Repay Is What Really Matters
When you apply for a home loan, the bank or mortgage company will review your financial situation to make sure you have the ability to repay the debt. This is often referred to as repayment capacity, or the ability to repay. It’s one of the top concerns for lenders, when they review and approve borrowers for home loans.
It’s certainly possible to get a mortgage loan with a 5% down payment. But you’ll need to document your ability to repay that loan, while keeping up with all of your other recurring debts.
This is why mortgage lenders use the debt-to-income ratio, or DTI, as a key qualification criterion. This ratio compares the amount of money you earn (i.e., gross monthly income) to the amount you spend each month on your recurring debts.
- There is a “front-end” ratio that only looks at your non-housing debts, like your car payment and credit cards.
- There’s also a “back-end” DTI ratio that takes all of your recurring debts into account, including the mortgage payment.
Generally speaking, lenders prefer to see a back-end or total DTI ratio no higher than 45%. That number is not written in stone, but it does represent the current threshold for a lot of lenders.
If your debt ratio is much higher than that, it might be harder to qualify for a loan. A higher debt ratio suggests that a person might not be able to repay their loan obligation.
So, if you have the income needed to repay your loan while managing all other debts, you could probably qualify for a mortgage loan with a 5% down payment.
In the End, It’s a Matter of Priorities
A lot of borrowers who can afford a larger down payment choose to put at least 20% down when buying a house. They do this because it avoids the mortgage insurance “trigger” and therefore saves them money over the long run.
But not everyone can afford to put that much money down on a home purchase. For some borrowers, the highest priority is to minimize the upfront, out-of-pocket expense associated with a home purchase. In other words, they want to minimize their down payment. And there are mortgage programs available to help you meet that goal.
It really comes down to your priorities. A down payment of 5% is enough to qualify for mortgage loan. But it usually comes with the extra costs of mortgage insurance. And that in turn will increase the size of your monthly payments.
Disclaimer: This article includes generalized statements and scenarios that might not apply to your particular situation. Every borrowing scenario is different, because every borrower is different. Ultimately, the only person who can tell you if you’re qualified for a mortgage loan with a 5% down payment is a lender.