The down payment represents a portion of the purchase price, the buyer will take out a home loan for the remainder.
Down payments are required when buying many high-value items, including vehicles, condos, and houses. It’s common to make a down payment when purchasing a house.
What is a Down Payment?
A down payment is the amount of cash you pay towards the purchase to reduce the amount of money you’ll be financing.
For example: If you are buying a house for $200,000 and are making a down payment of $6000 (which is a 3% of the purchase price), than the home loan being financed is going to be for $194,000.
How Much Down Payment Do You Need?
Most would recommend that buyers put down at least a 20% down payment.
Simply, the higher the down payment, the lower your interest rate and the less you’ll pay for your home in the long run.
A 20% down payment is not always an option for some home buyers.
There are several loan programs with lower down payment options ranging from 3% to 20%. There are even zero down payment options for veterans.
The minimum down payment is going to depend on the loan program that you qualify for.
You can always put down more than the minimum.
Is 20% Down Ideal?
In most cases, paying a 20% down payment will help you avoid having to pay private mortgage insurance.
Though, many have found that paying mortgage insurance isn’t as a big a deal as they once thought. Some homeowners have found that they can refinance once they have reached enough equity to get rid of the mortgage insurance.
If paying 20% means depleting your entire savings account, then it’s likely not the best option.
You may end up needing the savings for unforeseen emergencies in the future. You will also have closing costs after everything is said and done, and you will want to have funds for that.
Options for Financing a Down Payment
It used to be that you can finance the down payment, these were called 80/20 home loans. Since the housing collapse that happened in 2008 lending guidelines have gotten stricter and the 80/20 loans were eradicated. Today, 80/20 loans are slowly coming back to the market but not many lenders offer them.
So, what are your options?
- Many people find it beneficial to pay for a down payment out of their own pocket. Saving money for a period of time can yield the funds required.
- You can also use money you made from selling your previous home.
- If you are having trouble saving money, you can also get the down payment from a family member, as a gift.
- You can also get a loan from your 401k. With most 401k accounts there is no penalty when using the funds for purchasing a home.
- A down payment can also be financed with a personal loan, however the personal loan debt will be used against your debt to income ratio.
Related: Best ways to save for a down payment
Low Down Payment Financing Options
If you simply don’t want to put down a 20% down payment, there are several lower down payment financing options.
FHA has a down payment requirement of at least 3.5% of the homes purchase price. Insured by the Federal Housing Administration, this is a government home loan.
FHA loans offer less risk to lenders, as they will pay the lender if the buyer defaults on the home loan. This allows for lenient qualifying guidelines.
FHA loans have lower, credit score requirements, some going as low as 500.
Note: If your score is below 580, FHA will require a 10% down payment. If you have a 0 credit score than the down payment is 3.5%
Coole Home has an FHA loan option as low as 1.5%. This option does require a minimum credit score of 640.
VA is a great option for veterans. They are guaranteed by the Department of Veteran Affairs and require no down payment.
This is also a government home loan and offers less risk to lenders. VA will pay the lender if the buyer defaults on the home loan. VA loans have lenient qualifying guidelines including bankruptcy and foreclosure waiting periods, and have low interest rates compared to other loan programs with no mortgage insurance.
USDA is another $0 down payment option. These are offered by the U.S. Department of Agriculture and are available to home-buyers in suburban areas (usually in areas with low population).
USDA loan is also a government loan but has stricter requirements than FHA and VA. It also has some income limitations and property restrictions.
Most people think that they need a 20% down payment for this program. This is not the case. There are lower down payment options. The credit score requirements on these loans are stricter than the government loans listed above. The debt to income ratio requirements are also stricter.
Minimum credit score requirement is 620.
Conventional comes with the following down payment options.
- 1% down payment
- 3% down payment
- 5% down payment
- 10% down payment
Benefits of a Larger Down Payment
While it may be tempting to put down the minimum down payment that is required, there are many benefits to offering something higher.
For one, there will be less of a monthly burden. Higher down payments usually mean lower monthly mortgage payments. Job loss or other unexpected financial burdens can affect your income, so it may be a good idea in the long run to opt for a higher down payment and lower monthly payments.
Lower interest rates are another big benefit of putting down a higher down payment. The higher the down payment the lower the interest rate.
Benefits of Smaller Down Payments
One of the biggest disadvantages to putting down a higher down payment, is it will take you longer to save the money, thus you may miss out on a great home.
If you are ready to get out of your current home or apartment, providing the minimum down payment requirement may be worth higher monthly payments.
You can always refinance out of the high interest rate once you’ve met the requirements.
Are you considering putting all your savings into financing a down payment? You may want to keep some of that savings for yourself, in case of an emergency. It’s usually never a good idea to completely empty out your bank account.
When you opt for a lower down payment, you can save the rest of that money for any required renovations. That extra money is also beneficial if you want to make home improvements.
Why is a Down Payment Required?
To lower the risk for the lender. A down payment indicates to lenders that you are responsible with your money and are less likely to miss payments or default on a loan.
Lenders also require down payments in the event the buyer defaults, the lender will have an easier time recovering losses.
When Does the Down Payment Have to Be Made?
While you may need to make an earnest money deposit with your initial offer on a home, the full down payment isn’t required until closing. The earnest money deposit will go towards your final down payment and lets the seller know you are committed to buying the home.
Closing Cost the same as down payment?
The down payment on a home is not the same as closing costs. Closing costs are charges for services like escrow, appraisal, title, underwriting. These costs are separate from the down payment.
The closing charges can be paid by you as the buyer, or can be negotiated to be paid by the seller. The down payment cannot be paid by the seller.
Related: Difference between Earnest Money and Down Payment
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