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How to Determine Your Down Payment on a Home

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How To Determine Your Down Payment on Home

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.

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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.

To learn more about buying a home and how the financing process works, read more from our experts by visiting our Mortgage Learning Center.

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  • Lil25

    40% DTI is good?? You’re kidding, right? We have just under 8% DTI, and we feel like we’re in over our heads. Of course, it doesn’t help that all our debt is from federal grad student loans with high interest rates. If we pay the 10-year minimum, we end up paying $30K just in interest over those 10 years! That’s just crazy. To avoid the high cost of interest, we need to get rid of student loans as soon as possible, so we are putting everything we can into paying off existing debt. How can we possibly afford a downpayment on a house at the same time? Now, if federal loan interest rates weren’t so insane… say 3% instead of 7%…. then we could easily afford to pay off the student loans at the normal 10 year rate and save up for a 10% downpayment… maybe even 20% at the same time!

  • Gerri Detweiler

    I am confused. If you already have a loan you should know the monthly payment…or do I misunderstand your question?

  • darling

    It is much easier to make a mortgage payment. Rent is higher than the mortgage would be. Take that into consideration for just a second.

    • WasRn

      BUT, What if you have more than enough for a down payment, closing costs, repairs to the house, etc. And you have a Credit Score of 820! And No debt! Drive a nice car. But you are Disabled! And your income, now is terrible. My Son & I would like to “buy together”; he has the income, but not great credit. Plus he was just laid off; from a Great job he had for only a year. But is working now. His rent & my rent could be a $ 1,500.00 a month mortgage payment. They should ask for the amount you pay for rent, & if you have had Any late payments, & how long you have been at that rental. I think that would prove a lot; like If you are stable, reliable, & you have been able to make at your rental payments. I think if you have been doing that for the past 10 years, they should take that into consideration. I think it says a lot to the Lender. Like this person cares about every aspect of their finances. I know I would never sink myself, & take on more than I could pay. I was a RN; life was easy! I’d give anything to be able to go back to work!! On disability I make in ONE month, what I did less than 2 shifts as a RN. Plus on disability, last month I paid a $1,800.00 hospital bill, & just paid $120.00 for Rx’s last week! My friend just retired from nursing with a $ 2000.00 a mo. retirement, plus she will get $ 1,800.00 in social security. Thats what I was planning, but Life had other plans for me, & it stinks, & makes me really upset that there isn’t a thing I can do about it. So isn’t there anyone who cares about people that have always done the right thing, & LOOK at the WHOLE picture to qualify for a loan. Take my Sons income, my credit score, our rental history, & each of our rental payments. Plus pay the entire down payment; If they did that we would qualify. So I guess we will just keep throwing away $1500.00 a month, on places we dont own. FYI: on the News tonight they said they are lowering the rates for the rich. For the houses the average american can’t afford. Something is very wrong, when we can’t do good for our average citizens. Lets just do it for the Rich, who do NOT need it. Nothing makes sense anymore!!

      • Home buyer

        Honestly, my husband and I just applied for a home loan and they don’t look at the higher of the two credit scores…they take the lowest one. (and they don’t average the two). My suggestion is to somehow work with someone to raise your sons credit score, or hold off for a bit.

  • Gerri Detweiler

    I have no idea. It’s really a financial planning question that can’t be answered that generally.

  • Gerri Detweiler

    Glad to hear things are moving in the right direction for you! Thanks for sharing this.

  • Jason

    I hope at this point, your question has been answered. There are lots of scenarios to look at, and as a realtor, I always tell my clients to check with a CPA. often, your mortgage will give you a great way as a tax write-off. So the more you put down, the less the write-off. In addition, there are so many programs being offered right now, that there may not be a reason to put so much down. IE: Putting only 20k down which might only raise your payment by $100, and you can put the other 20k in the stock market or another investment, and earn $150/mo. I hope that makes sense. :-) Good Luck!

  • Gregory Countee

    Hey buy or pay rent. Talk to me?.

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