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What Do You Need to Buy a House?

Buying a house can be a complex process. New approaches may make it easier, but it’s a good idea to understand all the key requirements and possible approaches.

By Karen Lynch | American Express Credit Intel Freelance Contributor

5 Min Read | November 30, 2020 in Money

 

At-A-Glance

Buying a new home usually requires a lot of cash upfront for the down payment on a conventional mortgage.

A wave of startup companies aim to provide you alternatives to lower your cash requirements.

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 Do You Need to Buy a House the Conventional Way?

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.

 

Down Payment Alternatives Offer New Spins on ‘Rent-to-Own’

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

  • Analyzes your financial profile.
  • Specifies a price range you can afford.
  • Pays cash for the house you choose.
  • Charges monthly rent for you to live there.
  • Adds about 20% extra to your rent – the company puts the extra amount toward building your equity in the home.

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:

  • Partial ownership: One startup would help you become a “partial owner” of the property it rents to you. As you buy more of the property over time, your rent goes down. Meanwhile, the startup manages the property, sharing the costs of repairs, taxes, and insurance in line with the percentage you own.7
  • One year to ownership: Another company operating in 10 states offers a one-year rent-to-own model, giving you time to get a mortgage and providing you with online tools and incentives to help improve your credit score and build up a down payment.8
  • All-cash offers: In hot real estate markets where multiple bidders compete for the same properties, one company touts its ability to make an all-cash offer on your behalf. The company charges an upfront fee and would then rent to you until you get a mortgage, either from the company itself or another lender.9

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.

 

The Takeaway

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.

Karen Lynch

Karen Lynch is a journalist who has covered global business, technology, finance, and related public policy issues for more than 30 years.

 

All Credit Intel content is written by freelance authors and commissioned and paid for by American Express. 

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