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Down Payments 101

Down Payments 101

Brittany Worrell Boyce
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Much of the home buying experience is fun and exciting, but when it comes time to discuss the financial side, it’s easy to feel overwhelmed. There was a time when purchasing a home meant having enough cash on hand to put 20% down at closing. But now, many buyers are opting for mortgage programs that offer more flexible financing terms. How do you determine what’s best for you? Like any major life decision, weighing the pros and cons of different home loan options will be key to deciding the right fit for your financial situation.

WHAT IS A DOWN PAYMENT?

When you buy a home, you know to expect a monthly mortgage payment that will be yours for 15 or 30 years, or until you’ve paid off the loan balance. The down payment, on the other hand, is a one-time cost that you’ll be responsible for paying at closing. Depending on the loan program you choose, your down payment could range from nothing all the way up to 20% of the purchase price (or even more, if you choose).

Your down payment is deducted from the overall amount of your new mortgage and will be the first bit of equity that you have in the home.

DOWN PAYMENT OPTIONS AVAILABLE TO YOU

Fortunately, there are many mortgage programs available that meet the needs of most homebuyers. Whether you have the resources to put 20% down or prefer to keep some of your savings and put a smaller down payment on your new home, you have options. In general, a conventional loan will require at least 3% down. Or, if you want to avoid Private Mortgage Insurance, 20% down is required. Some government-backed loans range from 0-3.5% down. A few government-insured options that you may consider include:

  • FHA loan – This program requires buyers to put down 3.5% of the home’s purchase price and will come with monthly mortgage insurance.
  • USDA loan – This program has no down payment, but mortgage insurance is required and can be paid upfront or financed into the loan for borrowers buying a home in an eligible rural area.
  • VA loan – This program is tailored specifically to active duty military, their families, and veterans and requires no down payment or monthly mortgage insurance, but the VA Guarantee Fee replaces mortgage insurance and is paid upfront.

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An advantage of a government-insured loan is the flexibility it offers and the requirements tend to be less stringent than those of a conventional loan, especially if you’re a first-time buyer who is still working on building good credit.

PROS AND CONS OF PUTTING 20% DOWN

As mentioned above, it’s not necessary to put 20% down in order to buy a home. However, there are certainly some convincing reasons why you’d want to consider it. Lenders take a financial risk when they lend a buyer money to purchase a home, but the larger the down payment, the less risk that the lender will face – because the buyer has more ‘skin in the game’, meaning they have more of their own money invested in the new home. A larger down payment can possibly help you:

  • Avoid or decrease fees paid upfront
  • Avoid private mortgage insurance for conventional loans
  • Decrease the overall amount you’ll need to borrow
  • Lower your monthly mortgage payment
  • Put more equity in the home from the beginning

On the flip side, there are reasons why a large down payment may not be the right option for you. If it would require you to drain your savings account in order to come up with 20% down, you should think twice. After all, something significant like a job loss or your HVAC system needing to be replaced will require you to have cash on hand to make ends meet.

It’s so important to have an emergency fund in place, especially as a homeowner – ideally, you should aim to save up an amount equaling at least six months worth of expenses.

BEST WAYS TO SAVE FOR A DOWN PAYMENT

The thought of saving thousands of dollars may seem overwhelming, but if you take it one step at a time, you’ll reach your goal and be on your way to becoming a homeowner in no time. There are several strategies that can help you get there even faster, including:

  • Saving your tax refund. If you received a refund on your taxes, rather than spending it, set it aside to put toward your down payment.
  • Eating at home. Hitting the drive-thru for a morning coffee or going out to lunch with co-workers is nice, but those expenses can add up quickly. By cutting these luxuries out – or minimizing them – you’ll find that reaching your savings goal is easier than ever.
  • Selling your stuff. Let’s face it, most of us have more material possessions than we could ever use – why not sell the things you aren’t using and make some cash? If you have items around your home collecting dust, consider holding a yard sale or selling these things on a resale site to earn extra money.
  • Getting creative. If you’re used to getting out of the house on the weekend, you don’t have to stop. Just scale back on the things that require money and find free or inexpensive activities, like a day trip to the beach, a picnic in the park or hiking with friends.

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Coming up with a down payment for your new home doesn’t have to be intimidating – in fact, there’s a huge reward after putting in the hard work – a brand new home to call your own. To learn more about the mortgage process, visit the Atlantic Bay blog.