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FHA Down Payments in California: The 3.5 Percent Rule

FHA loans are a popular financing option among home buyers in California. In 2020 they account for about 14% of all purchase loans nationwide, by dollar volume. First time buyers, in particular, enjoy the low down payment associated with this program.

Today, we will take a look at the minimum down payment requirements for FHA home loans in California, and other aspects of the program.

FHA Down Payment Requirements in California

Let’s start with the basics. California home buyers who use an FHA loan to buy a house in California typically have to put down at least 3.5% of the purchase price. That is the “Minimum Required Investment” (MRI), as the Federal Housing Administration calls it.

This program is managed by the Department of Housing and Urban Development (HUD). They outline these guidelines in a document called the Single Family Housing Policy Handbook. Here’s what the handbook says about the down payment for FHA-insured mortgage loans in California and nationwide:

Minimum Required Investment (MRI) refers to the Borrower’s contribution in cash or its equivalent required by Section 203(b)(9) of the National Housing Act, which represents at least 3.5 percent of the Adjusted Value of the Property.

Conversely, this means borrowers can finance up to 96.5% of the purchase price, when using this particular program.

That’s one reason why the FHA loan program appeals to first-time buyers in California. When you’re buying a first house or condo, you don’t have the proceeds from a previous home sale to put toward your purchase. Because of this, many first-time buyers in California struggled to come up with the funds needed for a down payment.

The FHA loan program offers a low down payment option for cash-strapped home buyers who can’t afford to make a larger investment.

Where Can the Money Come from?

We’ve covered the basics. The minimum down payment requirement for FHA loans in California is 3.5% of the purchase price or appraised value. Another common question is, where can the money come from?

HUD allows borrowers to use funds from a variety of sources. Basically, it can come from any legitimate source as long as it does not come from:

  • the person selling the home, or
  • anyone else who financially benefits from the transaction.

You can use your own cash, your savings account, retirement account withdrawals, etc.

You could also use money provided from an approved third-party donor, such as a family member or friend. But the money provided by the third party has to be a gift, and not loan. The donor must provide a letter stating they do not expect any kind of repayment.

Can I Borrow My Down Payment?

Department of Housing and Urban Development guidelines prohibit home buyers from borrowing money to put toward their FHA down payment. This means you cannot take out a loan from a bank (or borrow money from elsewhere) to cover your FHA down payment expense.

HUD refers to the down payment as a “minimum required investment,” because that’s how they view it. The idea is to have home buyers invest some of their own money into the deal. Studies have shown that borrowers who have more “skin in the game” are less likely to default on their mortgage loans down the road.

Aside from the VA and USDA loan programs, which offer 100% financing, nearly every mortgage product requires a down payment of some kind.

FHA Versus Conventional

If your top priority is to reduce the amount you pay upfront in the form of a down payment, you should also consider a conventional loan. A conventional mortgage product is one that is not insured by the federal government. This distinguishes them from FHA and other types of government-backed home loans.

In the past, the FHA program offered the lowest down payment for a lot of California home buyers. Conventional mortgages, on the other hand, typically required at least 5% down. But that has changed over the years.

These days, Fannie Mae and Freddie Mac will purchase loans from lenders with an LTV ratio up to 97%. This means eligible borrowers could use a conventional loan to buy a house in California with as little as 3% down. So the FHA isn’t the only game in town, when it comes to minimizing your upfront expense.

More info on FHA loan requirements

How Mortgage Insurance Plays Into This

Regardless of which type of loan you use, you will probably have to pay mortgage insurance when making a down payment in the 3% range. (VA loans are a notable exception to this general rule.) So then it becomes a question of which type of mortgage insurance is more affordable for you, as the borrower.

In some cases, private mortgage insurance (PMI) for a conventional loan can cost less than the government-required insurance on FHA mortgage loans. This is why it’s so important to compare “apples to apples” when shopping for a loan. You want to consider the upfront and the long-term costs, to determine the best financing method for you.

We’ve mentioned VA loan several times in this article. If you currently serve in the military or have in the past, you owe it to yourself to consider the VA loan program. As mentioned above, the minimum down payment for an FHA mortgage in California is 3.5%.

The VA program, on the other hand, allows eligible home buyers to purchase a house with no down payment whatsoever. You could also avoid mortgage insurance at same time. It’s hard to beat those benefits!

Have questions? Bridgepoint Funding offers a variety of mortgage programs and serves the entire state of California. Please contact us if you have questions about FHA down payments or anything else covered in this article. We look forward to helping you.

Mike Trejo

Mike Trejo is a Bay Area mortgage broker with 20+ years of knowledge and experience.

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