By Karen Lynch | American Express Credit Intel Freelance Contributor
5 Min Read | November 30, 2020 in Life
When buying a new home the “conventional” way, you apply for a 30-year fixed-rate mortgage and make a big down payment – but you must be able to afford it. Because that conventional approach presents high hurdles for many people, new alternatives are emerging that might help you buy the house you want without needing all that cash right away.
Startup companies are using technology and innovative business models that put a new spin on concepts like rent-to-own and all-cash offers. Many of the companies are catering to younger millennials, whose homeownership rate is relatively low – 40.2% in the third quarter of 2020 for Americans under 35 years old.1 And they’re focusing on helping you avoid that big down payment, which experts see as one of the top financial obstacles to homeownership.
This article lays out what you need to buy a house “the old-fashioned way” versus the new alternatives emerging in many U.S. cities.
What you usually need to buy a house is 20% of the property’s price. This is the down payment most banks require for a conventional mortgage. With America’s average single-family home going for roughly $300,000 in 2020,2 that means you’d have to come up with at least $60,000 – plus closing costs that usually amount to between 2% and 5% of the selling price. Then you’d typically have to make monthly mortgage payments on the rest, at an interest rate of around 3% at this writing.3
Banks’ requirements don’t stop there. To get a conventional loan, you’ll usually need a credit score of at least 620, a solid credit history, proof of reliable income, a debt-to-income ratio of around 40% or lower, and more.4,5
If you can’t come up with a 20% down payment, the bank will probably ask you to buy private mortgage insurance (PMI) to cover its risk. In that case, you’d have to pay a mortgage insurance bill every month on top of your mortgage payment. For more, read “How Much of a Down Payment Do You Need to Buy a House?”
There’s another catch, though: Whoever is selling you a house usually prefers that you have an even bigger down payment than the banks require – and an all-cash offer is the “gold standard” in any situation where multiple potential buyers are bidding on a property. The theory is that the more money you offer to put down, the less chance there is of the bank denying your mortgage application. No homeowner wants to have to put their house back on the market after a buyer’s mortgage has fallen through.
These are just some of the typical hurdles you need to overcome to buy a house the conventional way – hurdles that drove entrepreneurs to launch companies offering unconventional alternatives.
Enter rent-to-own contracts that intend to significantly reduce cash requirements to buy a house. Startups in certain U.S. cities offer homebuyers the option to bypass down payments and monthly mortgage payments by paying something that looks a lot like rent. The difference is that a portion of the rent goes toward buying the property you are living in.
Rent-to-own real estate alternatives are not entirely new, but recent innovations aim to elevate the concept to a new level of ease and adoption. Various technologies are used: online apps to capture your financial profile, data science to analyze it and help match you to homes, apps for renters to track the equity they’re building toward buying, and more.
One company currently operates in six cities, with nationwide expansion plans. Its model, recently discussed in The Wall Street Journal, works like this:6
In this model, you would “own” about 10% of the home within three years, at which time you may qualify for some types of mortgages. If you decide not to purchase the property after all, you could still get 10% from the sale of the house to the next buyer, minus half the selling costs.
Different companies are doing variations of this model in a number of metropolitan areas, taking on the down payment barrier from several angles:
Some experts view these new arrangements as riskier than conventional mortgages. They advise working with an attorney before committing. And, while you may not need as much cash upfront for these alternatives, the bar could still be pretty high for your credit score and other aspects of your financial profile.
What do you need to buy a house? Usually, a lot of money upfront in the form of a down payment on a mortgage. But because down payments have long been considered one of the biggest financial hurdles to homeownership, some startups are offering alternative approaches that can lower the requirements you must meet to buy a house.
1 “Quarterly Residential Vacancies and Homeownership, Third Quarter 2020,” U.S. Census Bureau
2 “House Price Index Monthly Report,” Federal Housing Finance Agency
3 “Mortgage Applications Increase in Latest MBA Weekly Survey,” Mortgage Bankers Association
4 “What Credit Score Do I Need to Buy a House?,” Experian
5 “What Is a Debt-to-Income Ratio?,” Consumer Financial Protection Bureau
6 “Startups That Offer New Paths to Homeownership,” The Wall Street Journal
7 “Startup Explains its New, No-Mortgage Homeownership Model,” HousingWire
8 “What is Landis?,” Landis
9 “How it Works,” ZeroDown