Down payments are seen as a barrier to homeownership by many. However, this concept is often misunderstood. Contrary to popular belief, you may not need to use your entire savings to buy a home.
Here’s what you need to know about the down payment for your dream home.
What is a down payment?
A down payment is money you provide upfront to purchase a home rather than borrowing it from a lender. Lenders usually require a down payment to reduce the overall risk of loaning money.
Lenders have found that homeowners who invest their own money through a down payment are less likely to default on their mortgages. Down payments also help limit potential losses taken on by the lender if the borrower defaults on the loan and the home is foreclosed upon.
Finally, saving enough money for a down payment helps prove financial discipline and responsibility on the buyer’s part.
How much down payment do you need for different types of loans?
The down payment you’ll need depends on the type of mortgage loan you’re using to finance your home purchase. The most common mortgage loan types include conventional, FHA, jumbo, and VA loans.
Conventional mortgage loans
A conventional mortgage loan is the most common type of loan used to purchase a home. Conventional mortgage loans used to require a 20% down payment. Today, the terms are more flexible and accessible for first-time homebuyers who may not be able to provide significant funds for a down payment.
You can put down as little as 3% of the home’s purchase price as a down payment for a conventional mortgage loan. Exact requirements vary depending on the lender and your qualifications. Your down payment amount may also affect your monthly mortgage payments.
FHA mortgage loans
An FHA mortgage loan is a federal loan program that the Federal Housing Administration guarantees. When the federal government guarantees mortgage loans, it decreases the risk taken on by lenders.
The goal of FHA loans is to reduce the risk taken by lenders to encourage them to provide loans to those who wouldn’t otherwise qualify. As a result, FHA loans are more accessible to homebuyers with lower incomes, credit scores, and less access to capital.
If you have a credit score above 580, you have to put at least 3.5% down with an FHA loan. If your credit score is below 580, but above 500 (the minimum score for an FHA loan), you have a minimum down payment of at least 10%.
These loans also require an annual mortgage insurance premium (MIP) throughout the life of the loan.
3. Jumbo mortgage loans
A jumbo mortgage loan finances the purchase of a home at a price over the federal loan limit. The federal loan limit is set by the Federal Housing Finance Agency (FHFA). It prevents the federal housing entities of Fannie Mae and Freddie Mac from purchasing or otherwise guaranteeing these loans.
In most places in the United States, the conforming loan limit is $548,250. This may be higher in larger metropolitan areas with high costs of living.
Jumbo mortgage loans are riskier for lenders, and they often require larger down payments to help mitigate this increased risk. Specific down payment requirements vary based on the lender and your qualifications, but you should expect to put at least 10% down towards purchasing a home using a jumbo mortgage loan.
4. VA loans
A VA loan is a federal loan program guaranteed by the U.S. Department of Veterans Affairs. This type of loan is available to active service members, veterans, and their families to help purchase a home. VA loans do not require a down payment.
VA loans also do not require mortgage insurance for lower down payment amounts, a cost that usually comes alongside conventional and FHA loans. Instead, buyers will pay a lesser funding fee to cover the cost of the loan program.
This fee can be waived in certain circumstances, for instance, if the veteran is on disability, if the buyer is a surviving spouse, or if the veteran is a Purple Heart recipient.
How does your down payment affect your overall home buying process?
Just because you can use a small down payment to purchase a home doesn’t mean that you should. Your down payment can affect your mortgage terms, monthly payment, and overall home buying experience.
Here’s what you need to know about the pros and cons of using a small down payment to purchase a home.
Some of the pros for a home buyer using a small down payment include:
Making a home purchase faster than you would otherwise be able to because you don’t have to save as much
Being able to use leftover funds to cover other costs associated with buying a home, including closing costs, renovation costs, repair costs, and maintenance costs.
Some cons of using a small down payment include:
Taking out a larger mortgage, which means paying more in interest over the loan’s lifetime
Paying a higher interest rate, as low down payments are considered riskier for lenders
Paying private mortgage insurance (PMI) until you reach 20% equity in your home
How do you save for a downpayment?
Saving up for a down payment can be difficult without the right strategy. Here are some tips to help you save up for a down payment:
Sell some assets or investments like cars or stocks
Get a second job to earn more income
Reduce your expenses to save more money
Set up an automatic monthly transfer of funds into your savings account to make saving easier
Borrow funds from your 401k retirement plan
Borrow or receive funds from a relative as a gift
Always ensure the source of your down payment can be traced and is accepted by the lender.
The first place you can check is at the local level. Many states offer assistance for groups like first-time homebuyers. There are also programs at the national level through the U.S. Department of Housing and Development.
Finally, there are down payment assistance programs offered by non-governmental organizations. For instance, your employer or a local non-profit may have a program. Conducting thorough research is key to finding down payment assistance programs that can help you purchase a home.