When You Don't Put 20% Down on a Mortgage
Nearly everyone who buys a home needs to borrow money in the form of a mortgage in order to finance it. Lenders commonly require you to pay 20% of the price of the home upfront. In the case of a $200,000 home, that's $40,000, which is still an awful lot of money. When possible, many buyers strive to put the 20% down. However, if your finances simply cannot provide that much cash, there are alternatives.
Pay for Mortgage Insurance
Mortgage insurance protects the lender in the case of you defaulting on the loan. When you pay back the loan, you're gaining equity, but everything else you pay – like interest and insurance – is just money going into someone else's pockets.
And it's not a small amount of money. Mortgage insurance can cost hundreds of dollars per month, putting a real strain on finances.
Get a Second Mortgage
While your first mortgage is covering 80% of the price of the home, a second mortgage may fill the gap between what you can pay and what that first mortgage is paying. A commonly encountered issue is second mortgages have higher interest rates than first mortgages. Once again, that's more money going into someone else's pocket and less going into equity.
Borrow Against Retirement Accounts
While you generally can't touch money sitting in retirement accounts like 401(k)s, there are exceptions. You may borrow against that money for things like down payments. Essentially, you're loaning yourself the money.
Interest rates are typically low in this situation. More importantly, you're paying that money back to yourself. It all goes back into the account where it will wait for you until you retire. However, there are substantial penalties if you default, making it even more crucial to pay your debts on time.
Have Money Gifted To You
If someone is willing to to gift you the money, remember you can usually receive up to $14,000 before it becomes taxable. Just remember that you may need to prove to your lender that this is a gift and not a loan.
Get a Personal Loan
People, particularly family or very close friends, are sometimes willing to loan money, particularly if you'll be paying interest. Those in retirement may find it most beneficial to lend money. The interest is a way for them to bring in income and they are more likely to have the savings to do it.
Pay a Higher Monthly Payment
No matter how you finance your home, remember that smaller down payments mean larger monthly payments. That is an obligation which will follow you for many years, so consider it carefully. And you're paying interest on all of it, further raising your monthly bill.
That higher payment also makes it harder to get the mortgage in the first place. The Consumer Financial Protection Bureau requires borrowers to have no greater than a 43% debt-to-income ratio. That means all of your debt – credit card bills, car payments, mortgages and so forth, can't be more than 43% of your income. The higher the monthly rate, the less likely you'll fit that criteria.
And there's good reason for that rule. The more debt you're trying to pay back, the less money you have for things like food and utility bills. The limitation is meant to keep you from getting in over your head with financial responsibility.
Putting 20% down on a mortgage is considered by many to be the path of least resistance when financing a home. However, if that simply isn't in the cards, there are alternatives. Consider the ramifications of those options carefully. Money saved on the down payment now frequently costs far more in the long run.