Estimate Your Price Range

Step 3: Determine your down payment

What, Why, How

What is a down payment?

When you buy a home, it is typical for you to provide some of your own money in addition to the money you take out on loan. The money you provide of your own is considered the “down payment.”

Homebuyers are typically required to contribute a down payment equal to 3-20% of the sales price of the home. Zero percent down loans are also available, though due to the subprime lending crisis, fewer lenders are willing to lend to homebuyers who have no down payment.

Why is a down payment such an important aspect of buying a home?

Lenders often require down payments. And the bigger the down payment you can provide, the better. Here’s why:

• The larger your down payment, the less you have to borrow, and therefore, the lower your monthly payments.
• If you have a very small down payment, i.e., 5% or less, you will be eligible for fewer types of mortgages and may be charged a higher interest rate.
• The bigger the down payment you are able to put down, the more banks will be willing to loan you. (And the more willing they will be to loan to you at all.)
• For any down payment less than 20% of the asking price, you will be asked to pay Private Mortgage Insurance (PMI).
• Lenders sometimes allow sellers to cover less of the closing costs when a buyer has a very small down payment.

The down payment can also act as a reality check; if you haven’t been able to save even a minimal down payment of 3-5%, you should ask yourself whether you are financially ready to buy a home. Reflect on why you have not been able to save, and think hard about whether you would be able to keep up with your mortgage payments, assuming you could find 100% financing. While it might be stressful to continue renting instead of buying, think of it this way: renting is less stressful than losing your home due to foreclosure because you were unable to pay the mortgage payments.

How can I buy a home if I only have a small amount of money to put toward a down payment?

A limiting factor for many homebuyers is the lack of an adequate down payment, and in the wake of the subprime crisis, there are fewer lenders offering 100% financing.  So how can you buy a home without a significant down payment?

Save instead of paying off debt (assuming you have a good debt-to-income ratio)
If you have a good job and are concentrating on paying off debt, it probably makes sense to put something into the savings account instead. Many people can easily handle the debt they have and think that lenders want them to be debt free. Not so. They just want your debt-to-income ratio to be within the guidelines. So long as your ratios are less than, say, the mid-40% range, having a down payment will be more important than a lower debt load. Your goal should be to accumulate a 5% down payment.

Look into 100% financing (but only if you feel you will be capable of making the monthly payments)
Let’s assume that you want to buy now, and you have a small down payment saved, say $5,000.   Well, you have several options. The Federal Housing Administration (FHA) and the Department of Veterans Affairs (VA) have been doing 100% financing for years, although the rate for these loans may be higher than other options. Conventional loans that are sold to FannieMae and FreddieMac, the two giant organizations that buy most of the loans originated these days, may offer better options. Both agencies have introduced programs to help buyers who have scarce resources.

If you can secure 100% financing, be aware that there is a catch.  With these programs, you have to pay Private Mortgage Insurance – PMI – and you may have to be able to contribute at least 3% of the selling price to closing costs. That’s OK. You have $5,000.

Several lenders have programs that provide 100% financing without PMI, but the rate is correspondingly higher. Bottom line, the differences between these programs may be minimal. Remember that you can also eliminate PMI as soon as your home appreciates to the point where your loan equals 80% of the new, higher, value of your home.

80/20 loans
You can also do a “piggyback” transaction: a 1st loan for 80% of the value, and a 2nd loan for the other 20%.   There is nothing wrong with this kind of transaction and it is very popular as PMI is not typically required.   Usually the 1st must be a 30-year fixed rate loan, but there are a large number of fixed rate and variable rate options for the 2nd loan.

Be sure you are ready
So, as you see, there are programs to help you if you do not have a substantial down payment. But remember—these programs will help you to secure loans, but not to make your monthly payments, so be sure you are financially ready before taking on 100% financing.

If you are receiving money from friends or family
Many homebuyers receive money from friends or family to buy homes. One important note to remember: the money you receive must be considered a gift, not a loan, or lenders will view the money as debt. This is not hard to prove—your relative or friend typically only needs to write a letter indicating the money is a gift, not a loan.

Remember closing costs, moving costs, etc…
Also, keep in mind that not all of your available money can be put toward a down payment. Closing costs, moving costs, repairs to the new home, new furniture needs, etc., should also be taken into consideration.