When it comes to buying a home, many people assume that you need to save up for a 20% down payment. However, this isn’t always the case. In reality, there are many types of mortgage loans that allow for much lower down payments, including the popular 3%-down conventional loan.

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What is a 3%-Down Mortgage?

A 3%-down mortgage is a type of conventional loan that allows you to put down just 3% of the purchase price when taking out a mortgage. These loans are offered by private mortgage lenders, but their rules are set by Fannie Mae and Freddie Mac, the government-sponsored enterprises that keep money flowing into the mortgage market.

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How to Qualify for a 3%-Down Mortgage

To qualify for a 3%-down conventional mortgage, you’ll first need to have the 3% saved up and ready to go in your bank account. Beyond this, there are some other requirements you’ll need to meet, which can vary by mortgage lender but typically include:

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• A credit score of at least 620
• Buying a primary residence
• A debt-to-income ratio of 45% or less
• Taking a homeownership education course

For some types of 3%-down loans, you may also need to fall under a certain income limit or be a first-time home buyer.

Mortgage Insurance Requirements

When you make a 3% down payment on a conventional loan, or any amount under 20%, you’ll have to pay for private mortgage insurance (PMI). PMI protects your lender in case you default on your loan and serves as a way of compensating for the extra risk that a low-down-payment loan entails. It’s usually included as part of your monthly mortgage payments, though some lenders require you to pay up front at closing or a combination of the two. Generally speaking, you can expect PMI to add about $30 to $70 to your monthly payment for every $100,000 you borrow.

Fortunately, you can request that your mortgage lender cancel your PMI once you reach 20% equity in your home, or when your loan balance is 80% or less of your home’s value. Your lender must automatically cancel your PMI policy once the balance falls under 78% of your home’s value.

Pros and Cons of 3%-Down-Payment Mortgage Loans

The big benefit of using a 3%-down mortgage is that you need a lot less cash up front to buy a house, which means less time spent saving and potentially allowing you to purchase a home sooner than expected. You may also free up cash to put toward other expenses, such as purchasing new furniture or decor, or renovating specific areas of your new house.

On the downside, though, you’ll have to pay for PMI, which adds to your monthly mortgage payment. A small down payment also means you’ll build equity more slowly, as the bulk of your payments will go toward your interest costs for the first few years of the loan. This could increase the chance of going upside down on your mortgage if your home’s value falls.

Last but not least, a smaller down payment means a larger loan balance, which increases your total interest costs over the long haul.

Alternatives to the 3%-Down-Payment Mortgage

The 3% conventional loan isn’t your only option if you want to avoid making a large down payment. Here are some other common mortgage types to explore:

• FHA loans: These are mortgages insured by the Federal Housing Administration. If you have a credit score of at least 580, the FHA only requires a 3.5% down payment. (With a credit score of 500 to 579, you’ll need 10% down.) You’ll have to pay a mortgage insurance premium, which lasts for the life of your loan in most cases.
• VA loans: These are loans backed by the U.S. Department of Veterans Affairs and are available to eligible military members, veterans, and their spouses. They require zero down payment or mortgage insurance.
• USDA loans: These are another type of no-down-payment loan. They’re guaranteed by the U.S. Department of Agriculture and can only be used for home purchases in designated rural parts of the country. You must also meet certain income requirements.
• Down payment assistance programs: These can also help you buy a house with less up-front cash. These are sometimes offered as grants that do not need to be repaid, low-interest loans, or loans that are eventually forgiven if you meet specific requirements.

This article has covered the ins and outs of 3%-down mortgage loans, including the benefits and drawbacks of using this type of mortgage, as well as some alternative options to consider. Whether you’re a first-time home buyer or a seasoned pro, understanding your mortgage options is key to making an informed decision and finding the right loan for your needs.