There’s a lot to learn when you’re in the market for a new home, from the documents you’ll be reading over and signing to figuring out all the financial aspects of buying a home. One of the biggest parts of getting a new home is figuring out the terms and conditions of your mortgage. Two major influencers of this are your credit and your down payment.
What Is a Down Payment?
When someone buys a home, it is common for them to provide some of their own money upfront (separate from what they’ll pay each month on their mortgage). This money serves as the down payment for the home. Many buyers find that coming up with a down payment on a house is the most challenging aspect of the home buying process, so it’s a good idea to examine your finances early so you have a better idea of what you’ll be able to pay. There are plenty of tools online for seeing how much home you can afford based on your down payment and other factors, including this handy one on Credit.com.
It’s important to note that the more money you put down upfront, the lower your monthly mortgage payments will be. Many home loans require a specific down payment — this is typically equal to 3% to 20% of the sales price of the home. There are 0%-down loans available, but they narrow your options, as fewer lenders are willing to lend to homebuyers who have no down payment.
Your Credit Scores
As we mentioned earlier, beyond your down payment, your credit scores play a role in your mortgage. (Not sure where your credit currently stands? You can view two of your credit scores for free, updated every 14 days, on Credit.com.) Your credit history and debt in relation to total assets can also affect how much you’re able to borrow and what types of home loans you may qualify for.
The Impact a Down Payment Has on Buying a Home
As we mentioned, lenders typically require down payments before approving your home loan, so that’s a major reason as to why they’re so important. These are some other ways your down payment impacts your home buying experience.
- The larger your down payment, the less you’ll have to cover with a mortgage, and therefore, the lower your monthly loan payments will be.
- If you have a very small down payment, you likely limit the number of mortgages you’re eligible for and may even be charged a higher interest rate on those you do qualify for..
- On the flip side, the more you can put down, the more mortgage options you’ll have.
- For any down payment less than 20% of the asking price, your lender may ask you to also 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% to 5% of the price of a house you’re considering, it’s wise to 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 full financing. While it might be stressful to continue renting instead of buying, you may want to think of it this way: Renting for a while longer will be less stressful than losing your home to foreclosure because you were unable to pay the mortgage payments.
Can I Buy a Home With a Small 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. Having a small down payment is typically better than none at all, but of course neither of these is ideal. So, how can you buy a home without a significant down payment? Here are a few options if you find yourself in this situation.
Focus on Saving More
If you have a good debt-to-income ratio (income compared to your current debt obligations), this may be something to consider. Many people can easily handle the debt they have but think lenders want them to be completely debt-free before applying for a mortgage, which isn’t necessarily the case. The general rule of thumb is that your debt-to-income (DTI) ratio should be 43%, though some lenders may give you a mortgage if your DTI is more than that. (Note: This does not mean you should avoid paying off debt or skip payments all together.)
Look Into 100% Financing
Another type of home loan is the 100% financing home loan — meaning, your mortgage covers the entire cost of purchasing a home, eliminating the need for a down payment. While this may sound ideal, keep in mind that you’ll still need to pay the closing costs, will likely have to pay PMI, and will have much higher monthly payments than you would if you made a down payment.
The Federal Housing Administration (FHA), the Department of Veterans Affairs (VA) and the United States Department of Agriculture (USDA) all offer types of 100% financing loans you may want to consider. Just keep in mind — the interest rate for these loans may be higher than other options.
Another option is doing a “piggyback” transaction: What this means is you’ll get your main mortgage for 80% of the price of the home, make at least a 10% down payment, and take out a second home loan to cover the other 10% (or whatever is left over after you pay your down payment). Keep in mind, you’ll also be required to pay closing costs with this option and PMI is not typically required. The 80/20 option used to be quite popular but, after the housing bubble burst, this option became more scarce.
Be Sure You Are Ready
There are programs to help you if you do not have a substantial down payment. But remember: These programs will help you secure loans but not make your monthly payments, so be sure you are financially ready to do so on your own before taking on 100% financing.
Receiving Money from Friends or Family
Many homebuyers receive money from friends or family to buy their house. If this is the situation you’re in, it’s important to remember that you need to distinguish the money as a gift instead of a loan, or lenders will view the money as debt. This is not hard to prove — your relative or friend (or whoever gifted you the money) typically needs to write a letter indicating the money is a gift, not a loan. You may want to talk with your lender or financial adviser about this to make sure you’re following the proper procedure.
Remember Additional Costs
While it’s certainly a good idea to make a large down payment on a house, you don’t want to overspend there either, as there are other expenses you’ll face with buying a house. Closing costs, moving costs, repairs to the new home, new furniture needs etc. should also be taken into consideration when budgeting for your new house.