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What You Need to Know About Down Payments When Buying a Home

What is a Down Payment?

A down payment is the fraction of the house’s purchase price that you contribute upfront at the closing stage. The rest, which is the balance after deducting your down payment from the purchase price, results in your loan amount.

While each loan program comes with its own minimum down payment requirement, most people advise to put as much as you can into the down payment when buying a house. The thought process is, the more money you invest in your home initially, the less you need to borrow, which ultimately results in lower monthly payments and less interest paid over the loan term. Don’t always take that approach though… Sometimes, it may be better to have less skin in the game. It really depends on what your goals are. This is a conversation you should have with a licensed mortgage consultant.

What Does a Minimum Down Payment Mean?

The minimum down payment is the least amount of money that a lender will require you to contribute towards the purchase of the home. This amount is always calculated as a percentage of the purchase price and can differ for each type of home loan.

What is the Required Minimum Down Payment for Each Type of Mortgage?

You may have several loan options when buying a house, so knowing the minimum down payment for a mortgage for each loan type can assist you in choosing the right loan. Keep in mind that the down payment requirements below are as of 2023. You should engage a licensed mortgage consultant to get an overview of what the current options are, as they may have changed by the time you read this. The likelihood of change to these terms is low, but always make sure you have updated information before you start making any decisions.

Conventional Loans

You may hear “Fannie Mae” or “Freddie Mac” being tossed around as you start the home buying process. They are two of the main sources of liquidity for mortgage loan funds. Look at it this way - lenders will sell a high percentage of the conventional loans they originate to Fannie and Freddie who ultimately package a bunch of loans into a mortgage backed security and sell it to investors who receive part of the monthly interest payments. This process will be discussed in a future blog post. For now, the important thing to note is that most conventional lenders require a 3% down payment for first-time buyers and 5% for returning home buyers. However, they may ask for a larger down payment if your credit score is low or if you have a high debt-to-income ratio. Often times, the minimum credit score for these loans is 620. There are conventional loan limits in place based on the county your home resides in and you need to make sure that your loan amount, after down payment, fits inside the max allowable loan limit. Again, engage a licensed mortgage consultant to help you with this, but you can take a look here and make sure you choose “Limit Type” as “Fannie/Freddie” on the search. Keep in mind that as the number of units increases, the loan limits also increase, e.g., the loan limit on a single family home is lower than the loan limit on a 2 family home.

FHA Loans

FHA loans, backed by the government, are suitable for borrowers with less-than-perfect credit or a high debt-to-income ratio. For this type of loan, borrowers need at least a 580 credit score and a minimum down payment of 3.5% of the sale price. Some lenders may approve borrowers with a credit score of 500 – 579 but typically with a 10% down payment. Similar to conventional loans, there are loan limits set based on the county you live in. See the same link as above here, and choose “FHA Forward” in the “Loan Limits” dropdown to take a look at your county’s loan limits for an FHA transaction.

Jumbo Loans

Jumbo loans are loans that exceed conventional loan limits. In 2023, these limits are $726,200 in most parts of the country and $1,089,000 for high-cost areas like Alaska and Hawaii. Most jumbo loan lenders require a larger down payment than the traditional 3% - 5% because they represent a larger investment for the lender.

Are Zero-Down-Payment Loans Available?

Some loan programs, including two government-backed options – USDA and VA loans – do not require a down payment:

USDA Loans

USDA loans are intended for low to moderate income families wishing to live in a designated rural area. Unlike VA loans, borrowers can purchase a home anywhere as long as it is their primary residence, and they qualify for the loan. You can check to see if you are eligible for a USDA loan here. You not only need to be in an area designated by USDA as rural, but you also need to not exceed certain income limits.

VA Loans

VA loans are a government-backed program for veterans, current military members, and eligible surviving spouses. Like USDA loans, VA loans don’t require a down payment, and borrowers can add the closing costs to their loans.

Avoiding Private Mortgage Insurance (PMI)

PMI is an insurance policy that you as the borrower pay to insure the lender in the instance of default on conventional loans. PMI is applicable when you as the borrower put less than 20% down on the transaction. When less than 20% is put down on the transaction, risk is introduced to the lender. To avoid paying private mortgage insurance (PMI), borrowers need to put at least 20% down on a home. However, you can get rid of PMI once your remaining loan amount is less than 80% of the property's value, meaning you've achieved 20% home equity. Keep in mind that any time you take an FHA mortgage, you will pay mortgage insurance regardless of the down payment. Discuss this with your licensed mortgage consultant for more details.

Effect of Down Payment on Getting Your Mortgage Loan Application Approved

A larger down payment may improve your chances of loan approval. Lenders prefer borrowers

who invest more in their homes as such borrowers are more likely to keep up with their payments.

What Is Earnest Money, and How Does It Relate To The Down Payment?

Earnest money is a deposit made by the buyer to demonstrate to the seller their intention to complete the purchase. This amount can go towards the down payment or closing costs and is provided at the time of execution of the purchase & sale agreement. The more you put down in earnest money, the more you look committed to the seller, as this earnest money deposit can be at risk if you cannot close on time. In most cases, the contract will contain language called “mortgage contingency,” which will basically state that in the instance you cannot be approved for financing, you are entitled to receive the earnest money back. This contingency clause is limited to a certain number of days, i.e., you need to figure out if you are approved or not within X number of days or you will be in a position where you may need to forfeit the earnest money deposit. Earnest money deposit and mortgage contingency are part of the negotiations process with your real estate professional and licensed mortgage consultant.

Is A Larger Down Payment Preferable To A Lower Down Payment?

A larger down payment can boost your chances of loan approval, potentially qualify you for lower interest rates, and reduce the total cost of your home. However, a smaller down payment might suffice if you're in need of stable housing, even if it means higher interest rates or PMI.

What Other Costs Do I Need To Consider Aside From the Down Payment?

In addition to the down payment, you need to account for closing costs, moving expenses, and the various costs associated with home ownership.

Closing costs cover the expenses to process and close your loan, moving expenses cover the cost of relocating, and new homeowner incidentals include costs like home repairs and utilities.

Final Thoughts: Buying a Home Requires Significant Financial Investment

Buying a home requires more than just the purchase price. A substantial down payment and funds for closing, moving, and unexpected expenses are necessary. Saving as much as you can to meet the minimum down payment for a house is the best way to ensure you get approved for the most favorable loan terms.

If you’re considering buying a home and have savings, you might want to apply online for a mortgage to see what financing terms you can secure. Click here to get started or schedule some time with me here to have an initial discussion.

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