If you’re in the market for a new home, there are many things you need to figure out before you make the leap to homeownership. A big obstacle to consider when you want to buy a house is your down payment. The amount you need to put down on the house depends on several factors. We’ve created this guide to help you understand a down payment and how much you’ll need to make one.
What Is a Down Payment?
A down payment is a payment made in cash at the onset of the purchase of an expensive good or service. It represents a percentage of the purchase price and is not refundable if the deal falls through because of the purchaser.
That said, a down payment is not the whole amount that will need to be settled with your title company at your closing time. In fact, you may elect to pay closing costs too.
Do You Need to Put 20% Down on a House?
In the past, it was common for home buyers to put down 20% of the home’s purchase price when using a conventional loan, and some lenders still prefer this minimum down payment amount. However, today many people put down less than 20%. This is partly due to the increase in home values, which makes the savings for a down payment more challenging, especially for first-time buyers.
A typical down payment to buy a house nowadays can be much lower than 20%, and in some cases, you may be able to find a loan with zero down.
What is the Minimum Down Payment Required for Buying a House?
While a 20% down payment is preferred by some lenders, your down payment may vary depending on the purchase price you pay for the house and who is providing the loan. For example, FHA loans may only require a 3% to 3.5% down payment, the minimum down payment you’ll likely find. Of course, the minimum down payment you make when buying a home can be anywhere between the highest down payment amount of 20% and the lower end of 3%.
Can You Buy a House With No Down Payment?
As stated earlier, you can find loans that require no money down. Currently, the loans that come with zero down are VA loans and USDA loans, and these types of loans have strict guidelines that need to be met in order to qualify. If you don’t qualify for this type of mortgage, you can expect to pay at least 3% to 3.5%, which is more typical in other loan types.
Pros of Making a Bigger Down Payment
These are some of the benefits associated with making a higher down payment that you should be aware of:
Pay less for your house
Interest on your mortgage is simple interest, meaning that your interest is not compounded or cannot gain interest on itself. Still, by making a larger down payment, you effectively reduce the amount you will ultimately pay for the home.
The following example uses and shows how putting different amounts down can lower your overall payment for your home, assuming a $250,000 loan. In the example below, we use a 30-year fixed-rate loan of 5%.
Down payment interest savings example
Taking out a loan for $250,000 would leave you with a mortgage-only payment of $1,342 per month. Over the life of that loan, if you paid your mortgage on time and put nothing else toward the loan’s principal, you would end up paying $483,139.
We will now run the numbers with a 5%, 10%, and 20% down payment.
Depending on which down payment you make, you would save $24,157, $48,313, or $96,627, respectively. That is almost a 100% return on your investment.
Lower your interest rate
Lenders are more likely to give you a better interest rate when you put down 20% compared to 5%.
Reduce your monthly mortgage payment
It doesn’t take a math whiz to realize that you will be required to pay less each month because paying a bigger down payment lowers the total loan amount, and you’ll end up paying less interest. When comparing a 5% and 20% down payment on a $200,000 home, you can easily see that the higher down payment lowers your monthly mortgage significantly.
Higher chance of your offer being accepted
This one may be a little more mythical than numerical, but it still carries weight. When faced with the decision between two offers on their home, where the only difference is the amount of the down payment, a seller is much more likely to choose the offer with the higher down payment. This is because the buyer putting down more looks more credible in the seller’s eyes and is less likely to have problems throughout the loan process.
This is even more true when looking to purchase a home in a competitive market at a competitive price point.
Pros of Making a Smaller Down Payment
Here’s a list of pros to consider if you’d like to make a smaller down payment:
Get into a home faster
Saving to buy a home is difficult. It can be very slow-going and painful.
When you are trying to purchase a home, the last thing you want to do is wait years and years to build up enough in a savings account for a large down payment. By putting less down, you will be able to get into a home more quickly.
Leave more in savings as an emergency fund
All things being equal, by putting less money toward your down payment, you will be able to keep more in your savings account. This means that if anything were to happen to your income stream, you wouldn’t be as at risk of defaulting on your home loan.
How Much Should Your Down Payment Be When Buying a House?
The answer to this question is not cut and dry. How much you need to put down on a home depends on the loan product that you are trying to use. VA loans or USDA home loans offer no-money-down options. If you don’t qualify for one of those loans, a down payment on an FHA loan, which the Federal Housing Authority backs, can be as little as 3.5%.
On average, home buyers put down anywhere from 8% to 20% on a home. Down payments, however, have multiple factors involved. For instance, you may have to raise your down payment as the price of a home rises.
You should also consider private mortgage insurance (PMI). Lenders require PMI when you don’t have more than 20% equity in a home. If your down payment is less than 20%, you’ll need to pay for this.
When thinking about how much you need to have for a down payment, consider the following:
How much do you have saved?
How much will you have left after making the down payment? The last thing that you would want is to save up all this money, get settled into your home, and then have an emergency happen that you couldn’t afford to pay for because all of your money is tied up in your home.
Putting 20% down is probably not the best choice for you if it will leave you with little to nothing in your savings account afterward. Bite the bullet of taking on mortgage insurance and work toward getting to that 20% equity mark (in which case you’d be let off the hook for the mortgage insurance).
How long are you planning to live in the home?
The longer you plan on staying in the home, the more valuable each dollar of the down payment becomes. If you plan on living in the home for less than ten years, then making a larger down payment may not be the best choice.
Are you an active investor?
With low mortgage interest rates, your down payment does not gain the greatest return on its money. That said, investing in real estate is a guaranteed return on your money (whatever interest rate you get) that you can’t get almost anywhere else.
What size monthly mortgage payment can you support?
If you have a lot of money saved up for a down payment but don’t have enough each month to support a higher mortgage payment, then putting more savings down is a good idea. This is especially true if putting more down is going to save you from mortgage insurance.
How does your credit score factor into your down payment?
Your credit score will affect the interest rate you will be approved for, but it might also affect how much you need to put down.
If you are applying for an FHA loan and have a score over 580, you should be able to qualify with only a 3.5% down payment. However, if your score is under 580 and you can qualify for the loan, you will have to put down 10%.
How To Pay Your Down Payment
The most common ways of paying a down payment at closing are checks, money orders, or wire transfers. Some people use a HELOC (home equity line of credit) or a 401(k) and even credit cards, though these aren’t recommended.
Unfortunately, not all of us will be able to save enough money to put toward the down payment on a new home. There are some unusual down payment options to consider, such as:
Can a down payment be a gift?
Yes, it can! However, there are some issues with monetary gifts that you will want to be aware of, even though they mainly apply to the gifter, not the giftee.
Just getting accused of committing mortgage fraud would be bad, but actually committing it would be worse. You must pay attention to what’s legal and what’s not when it comes to receiving a down payment as a gift.
There are more requirements, but you will need to have a signed letter that confirms your relationship with the person who is gifting you the down payment, stating that it is, in fact, a gift. You are not allowed to repay the gift — that would be regarded as a loan and may be considered mortgage fraud.
Another thing to be aware of is moving the money around well ahead of time. This is something that your lender will probably make sure happens, but the banks want to be able to trace the money that is being gifted to you for your down payment. They do this to ensure that it is coming from a legitimate source.
In most circumstances, you can receive a gift for the full amount of your down payment.
Is there a tax benefit to the down payment gift-giver?
No, not really. The gift-giver could incur an extra gift tax from the IRS if they were to go over the annual exclusion amount for a gift.
In short, as long as you don’t gift more than $15,000 as an individual or $30,000 as a joint tax-filing couple, you will not be hit with a gift tax.
How much is the gift tax?
This is where it can get a little convoluted. There is another piece of the puzzle called the lifetime gift tax exemption. This is a number, currently just over $11.5 million, that you can gift in your lifetime.
The lifetime exemption doesn’t come into play as long as you stay under the annual gift exemption amount. If you exceeded the annual allowable gift amount, the overage would be deducted from your lifetime gift total, leaving you with less than you can gift without taxing on it.
How can you use crowdsourcing as an alternative?
With platforms like Kickstarter and Indiegogo becoming so popular, it is no wonder that crowdsourcing has made its way into the home purchasing space. Some popular sites to crowdsource your down payment are HomeFundIt and Feather The Nest.
What is Down Payment Assistance?
Believe it or not, there are programs designed to help you pay down a home you would like to purchase. This is called Down Payment Assistance.
Each state has its own separate entities that take care of the down payment assistance programs. Less populated states have fewer programs, while other far more populated states have many more loan programs.
How do you qualify for down payment assistance?
The exact rules for how to qualify depending on the state you live in and the program you’re applying for. Some programs cater to specific groups, such as first responders, nurses, or veterans. Other programs care only about how much money you bring in annually.
To find out if you qualify, you have to research the programs your state offers.
To qualify for down payment assistance, do you have to be a first-time homebuyer?
You do have to be a first-time homebuyer to qualify for most of the programs. Fortunately, according to the Department of Housing and Urban Development (HUD), being a first-time home buyer just means that you haven’t had any ownership in a primary residence within the last three years.
If you owned a home that you sold five years ago, for example, and have been renting ever since, congratulations! You would be classified as a first-time home buyer and qualify for many down payment assistance programs.
As you can see, answering the question of how much you should put down on a home is not the easiest thing to do. You need to account for many variables to make the best decision for your specific needs. Hopefully, you now know at least a little more about down payments and can make a more informed decision.
If this is something that you are struggling with, I would advise that you seek out the opinion of a financial adviser or counselor who can help you navigate the process.
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Note By BiggerPockets: These are opinions written by the author and do not necessarily represent the opinions of BiggerPockets.