If you’re getting ready to buy a home — or at least start the process — you may have realized that this isn’t the easiest road to navigate. Buying a home can come with tons of questions on rates, lenders or even terms used during the loans process.
It also comes with questions about the down payment you’ll need to make on your home.
With the help of a mortgage calculator, you may have been able to crunch the numbers and determine if you’ve scraped together enough cash for the down payment. That’s not the only factor in this equation, though.
How large or small of a down payment you make will directly impact how much you’re paying on your home. It may even dictate what type of loan you qualify for. Down payments are a huge part of the loan process, and you need to make sure you have answers to your questions before you make any decisions. If you aren’t clear on how down payments work when buying a home, it could really end up costing you.
What is a mortgage down payment on a home?
A mortgage down payment is a portion of the total cost of the home that’s paid by the buyer when they purchase it with a mortgage loan. This upfront cost equals a percentage of the total cost of the home, and it is paid at closing.
The average down payment on a home is just 6% when averaging first time home buyers. That number is well below the recommended 20% down payment home buyers are advised to make.
[ Read: Home Financing Guide ]
Most lenders have a minimum down payment requirement for each type of loan or each financial circumstance. These requirements can be as low as 3% or much higher, but it will depend on a number of different factors. The important thing to know is that as long as you put down at least the minimum required by your lender, the total amount you put down is up to you.
Let’s say you want to purchase a home with a price tag of $200,000 and are considering putting down 20%. You are looking at paying $40,000 up front for your down payment. However, if your lender has a down payment requirement of 5%, you will only be required to put down $10,000. You can make either the $40,000 down payment or opt for an amount of $10,000 or higher to meet the lender’s requirement.
Why do you need a down payment?
There may be some confusion about whether or not you need a down payment when purchasing a home. It may not always be required of home buyers, but putting money down on a home can benefit both the buyer and the lender.
When homebuyers put money down on their homes, they are reducing their lender’s risk. Anytime a lender approves a mortgage loan, they are taking a risk. Simply put, the higher the loan amount, the higher the risk. Your down payment will lower the amount of money you need to borrow, which will lower the lender’s risk.
It can also benefit you to put down a larger down payment in the form of a low interest rate. Buyers with solid financial profiles, which include a decent down payment, are more likely to get the low rates the lender offers because of the lesser risk of lending.
Making a down payment also shows the lender you’re invested in the property, which means you’re more likely to make timely payments on your loan. It could mean the difference between loan approval and denial if you’re teetering on the edge of being approved.
How a down payment can work in your favor
Although coming up with the cash for a larger down payment can be a daunting task, it can also work in the home buyer’s favor. You do not technically own your home until you have repaid your mortgage loan, so if you put more money down, you own more of your home. This is called equity, and it can work in your favor later down the line, too. You can borrow against it if you need to, and it is building wealth for you as well.
It can also help you get approved for your loan. Less money will be needed from your lender to buy the home, so you will improve your chance of approval for a loan. If you are approved, you may get a lower interest rate thanks to that hefty down payment, which will save you money because you’ll pay less in total interest over the life of the loan. It could also result in smaller monthly mortgage payments.
You can also avoid having to pay for private mortgage insurance (PMI) if you put enough money down on a conventional loan. PMI is insurance that protects your lender — and it’s required for any borrower with a conventional loan putting less than 20% down. If you put down 20% or more, you’ll be able to avoid having this extra fee tacked onto your monthly mortgage payments.
Down payments for different types of mortgages
Your down payment will vary based on the type of mortgage loan you opt to use. You can expect your down payment requirement to be between 0% and 10% on average. For the loans that require no down payment, there may be extra requirements that home buyers need to meet to be eligible.
Federal Housing Administration loans, or FHA loans, are designed to have more lax requirements than conventional loans. That means home buyers with less-than-perfect credit or buyers with higher debt-to-income ratios can use these loans to purchase single-family and multi-family homes. Depending on the home buyer’s credit score and other factors, the down payment can be as little as 3.5% or as high as 10%.
It’s important to note that these types of loans come with their own type of mortgage insurance premiums, which are required of buyers no matter how large of a down payment they make.
VA loans are loans designed for veterans, active military service members and surviving spouses interested in purchasing a home. This type of loan doesn’t require a down payment, and you won’t have to pay for extra mortgage insurance, but the home cannot be for more than the home’s appraised value.
USDA loans are generally designed for low- and mid-income buyers who are interested in purchasing a home in qualifying a rural area. This type of loan doesn’t require a down payment, but it’s a lot more difficult to obtain than some of the other types of loans.
Conventional mortgage payments
Conventional loans, on the other hand, are loans that lenders set their own down payment requirements on. These loans have PMI for borrowers who don’t put down 20%, but it has to be removed after you’ve built 22% equity in the home.
For the most part, you’ll need a good credit score, a good debt-to-income ratio and a solid down payment to obtain a conventional loan. Your lender may have other requirements, too.
After the purchase of your home is complete, you have to start repaying your mortgage loan. For a predetermined amount of time, you will make monthly payments. The amount you pay every month will be based on your principal, interest rate and any other applicable fees, including taxes, mortgage insurance and escrow.
To calculate the monthly payment, a specific formula is used: principal + interest + fees = monthly payment amount.
[ Read: How to Calculate Your Mortgage ]
In most cases, if your loan term is 30 years with a conventional loan, you’ll pay the same amount each month for the next 30 years.
In some cases, however, the monthly payment will change. This happens if you have an adjustable-rate that can fluctuate during the life of the loan. Depending on the interest rate, the monthly payment would be higher or lower than it was the previous month.
You can get a better idea of how much your mortgage loan will cost you by using a mortgage payment calculator.
No down payment mortgages
It’s clear that a down payment works in your favor, but does that mean a no down payment mortgage works against you?
Not necessarily. No down payment mortgages mean homebuyers don’t have to stress about coming up with their down payment because they don’t have to make one.
Using the earlier example, if the home you purchase costs $200,000, rather than making a 5% down payment, or $10,000, which would leave you with a loan with a principal of $190,000, you would put no money down with this type of mortgage loan. Opting for a no down payment mortgage would leave you with a principal balance of $200,000.
While not having to come up with the money for down payment may sound nice, there are consequences when you opt for a no-down payment mortgage. If you select an USDA, FHA or other type of no-down payment mortgage loan, you may be stuck with a larger monthly mortgage payment and higher interest rate. This also puts you further away from owning your home because it will take you longer to repay your mortgage.
You’ll also pay more interest in total because you’re borrowing more money. You may end up paying well over what you would have been required to put down initially with this type of loan.
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