What Is a Down Payment and How Much Are They?
You’ve heard the term down payment before in reference to buying a house. A down payment is something a person must have if they need a loan to buy a house. But do you know what it really means? Do you know the definition of a down payment? Let’s take a look.
Down Payment Definition
A down payment is a large sum of money that you will pay when you buy a property. It is typically a percentage of the purchase price of the house. You will then get a mortgage or other type of loan to cover the remaining cost of the home. A down payment is something nearly everyone who buys a home must have, although there are a few exceptions that we will discuss later on.
Why do lenders require a down payment? Simply put, they see your ability to make a down payment as an indication that you are a lower risk. You are more likely to be able to pay down your mortgage if you had the ability to save up all that money. In addition to this, a down payment means they don’t need to lend you as much money.
How Much of a Down Payment Do You Need?
You will need between 3% and 20% for a down payment on a home. The ideal is at least 20%, because if you put down this much, you typically will not have to pay mortgage insurance. However, many people don’t have that big of a down payment. Fortunately, you can pay as little as 3%, but it depends on the type of loan you get. Let’s take a look at the different loan types and the down payment associated with each:
- Conventional mortgage: Provided by a bank or other traditional lender, this type of loan requires 3% down when you have a credit score of 620 or higher.
- Federal Housing Administration (FHA) loans: This is a government-backed loan that requires 3.5% down, along with a credit score of at least 580. If you have 10% down, you may be able to get a loan with a credit score as low as 500.
- U.S. Department of Agriculture (USDA) loans: This is a loan for low- and middle-income people who purchase a home in a USDA-eligible area. If you qualify, you don’t need a down payment.
- Veterans Affairs (VA) loans: These are loans for military members, veterans, and their spouses. No down payment is required for these loans.
- Native American Direct Loans (NADL): This is a loan provided by the VA to Native American veterans and their spouses to buy or build on trust land. No down payment is required.
How Does a Down Payment Work?
When you put in an offer on a home, you will need to pay a portion of the purchase price as the down payment. The larger the down payment is, the lower your monthly mortgage payments will be and the lower your interest rate will be.
When it comes to the interest rate on a home loan, lenders typically feel that a person who can put down a larger down payment is a lower risk. For this reason, they will often pay a lower interest rate than someone who puts down a small down payment.
In addition, the larger your down payment, the smaller the loan you will need form your lender. This will ultimately make your monthly payments lower, both because the interest is lower and because the principal loan amount is lower. For example, the difference between a 10% down payment and a 20% down payment may be more than $100 in terms of your monthly mortgage payment.
A Smaller Down Payment vs. a Larger Down Payment
When you are deciding whether to make a smaller or larger down payment, consider the following. A smaller down payment will mean:
- Buying your home sooner
- Having more money for closing and moving costs and repairs and renovations
- Having money set aside for an emergency fund or for other uses
A larger down payment will mean:
- Lower principal mortgage and lower interest rates for lower monthly payments
- No need to pay mortgage insurance (of your down payment is at least 20%)
- A lower debt-to-income (DTI) ratio
The Final Word
Keep in mind that although you need a down payment to buy a house, there are other costs you must consider, whether you are buying a new construction home or a resale home. You will need closing costs and you will need to be able to pay your moving expenses. You may also want money for renovations. Even if you qualify for a loan that doesn’t require a down payment, such as the USDA or VA loan, you will still be required to pay a funding fee.
For more information on how much you’ll need for a down payment, speak with one of our experienced team members today.
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