Down payments are often a key factor in the minds of homebuyers. How much money will you need to buy a home? What will that mean in terms of how much you can borrow and what your monthly payment will be?
Let’s begin with what a down payment is and its purpose. A down payment is the money, often expressed as a percentage of the sales price, that you pay at closing that goes directly to the sales price of the home. It is separate from any closing costs, which are taxes and fees paid to third-parties. Historically, the purpose of the down payment was to minimize the risk to the lender in two ways: first, it reduces the lender’s exposure if you default and provides some cushion to absorb costs associated with foreclosing and selling the home; allowing the lender to recover a larger share of their loan proceeds.
Second, the down payment was intended to represent a significant investment by the borrower. The “skin in the game” concept posits that a homebuyer will be less likely to default on the mortgage if they stand to lose a substantial amount of money that they invested in the home as well.
The down payment does factor in to how much home you can buy and what your payments will be in a couple of ways. First, the down payment goes directly toward the sales price, the more you put down, the more you can buy. For example, if the lender says you qualify for a $300,000 mortgage, the sales price of the home you buy can be that amount plus whatever down payment you have. If you have $15,000 available for a down payment, you can buy a $315,000 home; if you have $50,000 available, you can buy a $350,000 home.
Second, lower down payments do tend to result in higher interest rates and mortgage insurance premiums which means less of the payment you qualify for goes toward your principal balance. The result is the principal balance you qualify for is lower. Keep in mind that this is not always the case and may be different for your specific situation.
For some reason, many large media sources like TV news, newspapers, and business magazines nearly always talk about 20 percent when they talk about down payments. Sure, in an ideal world we would all put 20 percent down; or just pay cash for that matter. But it is not an ideal world and most of us do not have tens of thousands of dollars resting nicely in the bank while we look for a home. Some people may have the money available in retirement accounts or other investments, but it may not make sense to take the money out, which may incur a penalty, to use as a down payment. After all, with mortgage rates as low as they have been in recent years, the return on your investments may be higher than the cost of mortgage interest.
Since the introduction of mortgage insurance, a large majority of homebuyers put down far less than 20 percent. In fact, per industry sources, the average down payment has been shrinking for some time as more and more first-time buyers enter the market and loan requirements gradually loosened. There are several low- and no-down payment loans available for a variety of buyers, even with less-than-perfect credit. It is not uncommon for today’s homebuyer to put down 3 to 3.5 percent. In some circumstances, it may be possible to purchase a home with almost no money out of pocket at all. The best way to find out what options are available for your specific circumstances is to contact me. I can help you determine which loan programs will meet your needs so you have all the information you need to choose what is best for you.