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Oct 2017

4 Questions About Down Payments Answered

A big deterrent to buying a home is the “ominous down payment.” The thought of a large down payment has scared away many prospective homebuyers. While a down payment is most certainly a key player in the home buying process, there is a lot of misinterpretation and confusion surrounding the specifics of this lump sum.

In an effort to clear up any confusion (or anxiety) I’ve put together the following short list of four things you need to know about down payments.

1. What exactly is a down payment?

A down payment is the out-of-pocket money you pay upfront to the home’s seller. This payment is communicated as a percentage of the total selling price of the home. Once the down payment is made, the remaining amount is what you would borrow from your lender. For example, paying a 3% down payment of $9,000 on a $300,000 would leave you with a loan of $291,000. Alternatively, a 20% down payment of $60,000 would total your loan at $240,000.

Your loan product and comfort level will help determine how much you put down. The higher a down payment means a smaller loan amount, which may also decrease the amount of interest you pay over the life of your loan. Therefore, the higher your down payment amount, the lower your monthly mortgage payment.

Your down payment is also considered immediate equity in your home.

2. Why are down payments required?

Down payments help lower the risk of repayment to your lender. By saving up and establishing your capability of making a larger down payment, you illustrate financial strength and the ability to save. It also shows that you take this big investment seriously. In the event of foreclosure, the funds from your down payment will not be returned, thus further motivating you to make your mortgage payments.

3. What happens if you don't have a large down payment saved?

There’s a misunderstanding that all mortgages require a minimum of 20% down. But in fact, more than 70% of first time buyers made down payments of less than 20% during the last five years. So even though saving for a down payment may seem daunting, it’s more doable that you may think.

Some loan options will require a down payment of at least 3%, while others may require larger. For example, FHA loans require 3.5% while Conventional loans require at least 3%.

Depending on the loan program, the amount of down payment that’s required could also determine if mortgage insurance is required. For example, for Conventional loans, if the down payment is less than 20%, you will be required to pay private mortgage insurance (PMI). In addition to mortgage insurance, there may be additional required fees that are determined by the amount of the down payment.

Some loans even offer freedom from down payments all together. For example, VA loans don’t require a down payment for members of our military (active duty military, Veterans, National Guard members, reserve members, surviving military spouses,) and the upfront VA Guarantee Fee replaces mortgage insurance.

USDA loans also don’t require a down payment. This loan exists to help people with low-to moderate incomes affordably purchase homes in rural areas.

There are available state bond programs or state agency programs that can offer down payment assistance programs for qualified first-time homebuyers or anyone who hasn’t owned a home in the past three years. Keep in mind that some states and lenders vary.

4. Why should I put more money down?

Since there are several options available for lower down payments, you may be wondering why you’d opt for a larger down payment. By paying a larger down payment, you’ll ultimately spend less money on the total cost of your house. The following are key ways that a larger down payment will help you in the long run:

  • Avoid or lower upfront fees

  • Avoid needing private mortgage insurance for Conventional loans

  • Lower the total amount you will need to borrow from your lender

  • Lower your monthly mortgage payment

  • Provide more equity in home at the beginning of mortgage loan

Even though a down payment may seem intimidating, it doesn’t need to be. Talk to your mortgage banker about loan programs you may qualify for so you’ll have a more realistic understanding of what you’ll need to save. Who knows — it may be much less than you think.