Everything you need to know about mortgage down payments
What is a down payment?
Arguably one of the most talked-about subjects when it comes to buying a house is the down payment requirement. But really, what is a down payment? A down payment is a portion of the purchase price of a home that you pay upfront, and is not rolled into the loan amount. The down payment is then subtracted from the purchase price, which gives you your new loan amount. Here are a couple formulas that might help you out with this:
Down payment percent x purchase price = down payment amount
Purchase price – down payment amount = loan amount
For example, if you are buying a $200,000 house, and are putting 3.5% down, the math for your down payment and remaining loan amount will look like this:
3.5% x $200,000 = $7,000 down payment
$200,000 – $7,000 = $193,000
With that shown, you can clearly see what your down payment is and how it affects your loan amount.
But, how much do I actually have to put down?
So, now that you know what a down payment is in relation to your mortgage loan, you’re probably wondering about how much you actually need to put down. This is where things can get “scary” for most first-time home buyers. You’ve likely heard all of the rumors about lenders requiring 10-20% down payments for mortgages, and for some people, that feels like it will be impossible to save up. The good news is that the 10-20% down payment rumor is just that – a rumor and a common misconception about mortgage loans.
All loan programs have different guidelines on what down payment is required. But I’ll break down the loan programs that we offer with their requirements and you’ll see that your down payment amount may be more attainable than you thought.
- FHA – 3.5% down for everyone, regardless of if you’ve bought a home before or not
- USDA Rural Development Loan – 0% down (you read that right, no down payment required!)
- Conventional – 3% down for first-time home buyers, 5% down for those who have owned a home in the last three years
- VA – 0% down. This is another special no down payment program for eligible veterans.
Why are down payments required?
As you’ve learned, down payments aren’t always a requirement if you are eligible for a USDA Rural Development loan or VA loan. There are also down payment assistance programs available to help those who may not qualify for either of those programs.
So, if it’s not a requirement for all loan programs, why is it considered a requirement at all? This can be a tricky question, but the general answer is that banks require down payments to lower the amount of risk that they are taking by loaning you money to buy a house. There are a couple of different ways that down payments can lower risks for banks:
- Home buyers who invest their own money into their home are less likely to default on a mortgage
- Being able to save up money or having assets available can show that the borrower has a greater sense of financial responsibility
- In the case that the bank does have to foreclose on the home, the amount of money that they lose is significantly less than if they were on the hook for the full purchase price
Should I save a bigger down payment?
Now that we’ve covered the minimum down payment requirements of our most popular loan programs, let’s talk about why you may (or may not) want to go above and beyond the requirement and put more money down.
It’s understood that down payments are typically the biggest obstacle for first-time homebuyers. In fact, the vast majority of first-time buyers utilize no down payment programs or simply put down the bare minimum of what they need. Here are the main reasons why:
- Smaller down payments are easier and take less time to save up
- You can take any left-over money that you have and use it to buy new furniture or save for other expenses that come up when owning a home
- Additional money that you have can be used to cover closing costs, instead of increasing down payment
With that being said, there are, of course, reasons why it’s sometimes better to put more down than just the minimum requirement.
- Larger down payments can make it easier to get qualified to purchase a home, especially if you have past credit issues
- Larger down payments will lower your loan amount even more, which means lower monthly payments on your mortgage note
- If you put 20% down or more, you can avoid having to also pay for PMI (or private mortgage insurance)*, which will reduce your monthly payment as well.
*PMI is a monthly fee added to the mortgage payment when you put less than 20% down.*
Whether or not to save for a larger down payment will depend on each individual’s unique scenario. Here are some things to consider when deciding on how much to put down:
- A 20% down payment can take many years for the average family to save.
- Use a cost-of-waiting calculator to see if waiting to save for a larger down payment is right for you
- Home prices tend to rise each year, which is great if you own the home already, but not so much if you’re eagerly waiting to buy
What type of down payments are acceptable?
Down payments do not always have to be saved in a bank account! While it’s traditionally thought that this is the only way to obtain your down payment funds, that’s not actually the case. There are a couple options available for acceptable down payment sources:
- Savings and checking accounts – this is the most common source of down payments. Accumulating money in your bank accounts until you finally have enough to put down is the easiest route to follow for some borrowers.
- 401k/Retirement accounts – this source is one that most people don’t consider when thinking about where the down payment funds will come from. You can withdraw money from your vested 401k or other retirement accounts to use as a down payment.
- Gifts funds – if you have a family member or employer who would like to help you out with buying a home by giving you a portion or all of your down payment, that’s completely acceptable! Although, funds from anyone who benefits from the sale of the subject property are not allowed.
While there are multiple options for down payment sources, one fact remains true for all of the above and that is that all funds must have a paper trail and be in an account of some shape or form, which means that NO cash is permitted for use in a mortgage transaction.
Ready to get started?
Now that we’ve covered the must-knows for mortgage down payments, it’s time to get started on getting pre-approved for a new home! Think you’re ready?