Understanding Down Payments

Buying a home is arguably the most expensive investment the average person will make in their lifetime. There are incredibly few people who can purchase a home outright without going through the home loan process and securing a mortgage. And anyone who has bought a home will tell you: the two things you must be prepared to invest are time and money.

While time has become an extremely valuable (and scarce) commodity in today’s society, money often plays more of a deciding factor in the home buying process.

As a matter of fact, one of the most important steps in buying a home is setting aside money for a down payment on your home loan.

What Is a Down Payment? 

A down payment for a home loan is a type of payment that accounts for a percentage of the home’s total sale price. Typically, down payments are anywhere from 3 to 20 percent of the home’s purchase price. You’re typically required to make the down payment upfront (it is usually counted as one of the closing costs of a mortgage transaction), as a way to reduce the lender’s risk of loaning money to you, and to show that you are capable of maintaining your mortgage without defaulting.

Down payments, in addition to credit scores, credit history, and your debt-to-income ratio (DTI), are common points of interest that lenders scrutinize. These factors help them determine whether they should loan you money or not, and how much money you are eligible to borrow.

What Is the Ideal Down Payment Amount? 

When shopping for a home, you will almost always hear about saving up enough money to make a down payment of 20% of the home’s sale price. If reading that last part sent even the tiniest of shivers up your spine, don’t worry, you’re not alone. While 20% is the ideal down payment amount, that doesn’t mean you are bound to pay it when shopping for a home. In fact, there are actually more people who don’t put 20% down -- especially on their first home.

Many home buyers cannot front that amount of money, and still walk away with an affordable mortgage and a beautiful home to enjoy. With most conventional loans, if you can’t make the 20% down payment, you will have to pay private mortgage insurance (PMI) as a part of your monthly mortgage payments. The PMI protects the lender in case you default on your loan.

Additionally, down payments also act as a bargaining chip of sorts. This is particularly true when negotiating interest rates. Typically, the higher the down payment, the better (lower) interest rate you are eligible to receive on your mortgage. That said, a down payment of 20% or more gives you your best chance at receiving the lowest possible interest rate.

Besides helping negotiate interest rates, making the ideal down payment amount of 20% can also help give you the competitive advantage to the seller of a home, when compared with buyers who cannot make such a large upfront payment.

Making the 20% down payment is definitely ideal, but in no way is it necessary for home ownership. The team at home.loans recommends that anyone who is looking to purchase a home start saving up money long before beginning the home buying process, but if you don’t have enough to cover 20% when the time comes, don’t stress. You still have plenty of options!

Purchasing a Home with Down Payment of Less than 20% 

Getting a conventional, conforming home loan with less than 20% of a down payment isn’t impossible -- but you’ll likely need great credit. If you don’t, there are some loan programs that are much more flexible with their down payment requirements than conventional loans. Beyond that, you may even be able to find down payment assistance programs that can help you source the money to make that 20%.

If you don’t have a 20% down payment, and your credit isn’t in great condition, consider one of the following special lender programs.

Special Lender Programs:

• FHA Loans: The most popular option for many home buyers is the FHA home loan, where eligible borrowers can put as little as 3.5% down. The trade-off is the inclusion of mandatory mortgage insurance premiums (MIP) that raise your monthly payments. MIP can either be paid at closing, or it can be rolled into the cost of your loan.

• VA Loans: Reserved for former or current members of the United States Armed forces (or applicable family members), you can get a VA home loan with no down payment. There is also a VA funding fee which must be paid.

• USDA Loans: These government-secured mortgages require no down payment, but are tailored for a specific population living in rigidly defined areas of the country that identify as low income.

• HomeReady Mortgages: Offered by Fannie Mae, HomeReady mortgages allow borrowers to pay as little as 3% down for a single unit of up to $417,000. Borrowers must be creditworthy to be eligible, but lenders will actually take into account the income of all household members (rather than just the applicant) when gauging your eligibility. Mortgage insurance is required for this loan.

• Conventional 97 Loan: Tailored toward first-time home buyers, the conventional 97 loan allows down payments as low as 3% for single unit homes, and comes packaged as a 30-year fixed rate mortgage.

Down Payment Assistance Programs:

• Employer-assisted housing (EAH) programs: Many employers across the nation offer home finance assistance to their employees, some of which include down payment assistance. Check with your company’s human resources department.

• Sellers can also provide down payment assistance. For example, if a seller wishes to speed up the home sale process, this may be an option to keep things moving along. They can even contribute to title insurance fees, property taxes, or closing costs among other things. There are limitations on how much a seller can help, however, based the type of home loan used.

• Many states have down payment assistance programs that cater to the local populations of cities and counties. There are actually over 2,000 of these programs in the country as of 2018! There are even resources to find down payment assistance programs that you are eligible for. Savvy buyers can also search for down payment assistance programs by state on the HUD website.