Coming up with enough cash for a down payment when buying a house is the single biggest roadblock for many hopeful home buyers.
But how much do buyers really need?
What is a down payment?
In real estate, a down payment is the amount of cash you put towards the purchase of home.
It is deducted from the total amount of your mortgage and represents the beginning equity — your ownership stake — in a house and property.
Down Payment Options
Many borrowers still believe that 20% is the minimum…and that’s just not the case. There are options from 0% to 20%+ that can work for many would-be buyers.
For today’s most widely-used purchase mortgage programs, down payment minimum requirements are:
- FHA Loan: 3.5% down payment minimum
- VA Loan: No down payment required
- HomeReady/Home Possible Conventional Loan (with PMI): 3%
- Conventional Loan (with PMI): 5%
- Conventional Loan (without PMI): 20% minimum
- USDA Loan: No Down Payment required
- Jumbo Loan: 10% down
PMI is “private mortgage insurance…and you can find out more about that here…
Remember, though, that these requirements are just the minimum. As a mortgage borrower, it’s your right to put down as much on a home as you like and, in some cases, it can make sense to put down more.
Benefits of a larger down payment
Conventional loans without mortgage insurance require a 20% down payment. That’s $60,000 on a $300,000 home, for example. There are a number of benefits to bringing in 20%:
- No mortgage insurance
- Lower interest rate, in most cases
- More equity in your home
- A lower monthly payment
As a reminder, the down payment is not the only upfront money you have to deal with. There are loan closing costs (you can find out more about those here…) and earnest money to consider as well. Before the dramatic music returns, let’s explore some lower down payment options.
Benefits of a smaller down payment
“A large down payment helps you afford more house with the same payment. In the example below, the buyer wants to spend no more than $1,000 a month for principal, interest, and mortgage insurance (when required).
Here’s how much house this home buyer can purchase at a 4 percent mortgage rate. The home price varies with the amount the buyer puts down.”
Even though a large down payment can help you afford more, by no means should home buyers use their last dollar to stretch their down payment level.
A down payment will lower your rate of return
“The first reason why conservative investors should monitor their down payment size is that the down payment will limit your home’s return on investment.
Consider a home which appreciates at the national average of near 5 percent.
Today, your home is worth $400,000. In a year, it’s worth $420,000. Regardless of your down payment, the home is worth twenty-thousand dollars more.
That down payment affected your rate of return.
- With 20% down on the home — $80,000 –your rate of return is 25%
- With 3% down on the home — $12,000 — your rate of return is 167%
That’s a huge difference.
However! We must also consider the higher mortgage rate plus mandatory private mortgage insurance which accompanies a conventional 97% LTV loan like this. Low-down-payment loans can cost more each month.
Assuming a 175 basis point (1.75%) bump from rate and PMI combined, then, and ignoring the homeowner’s tax-deductibility, we find that a low-down-payment homeowner pays an extra $6,780 per year to live in its home.”
Once you make your down payment, it’s tougher to get that money back
More from Green: “when you’re buying a home, there are other down payment considerations, too.
Namely, once you make a down payment, you can’t get access to those monies without an effort.
This is because, at the time of purchase, whatever down payment you make on the home gets converted immediately from cash into a different type of asset known as home equity.
Home equity is the monetary difference between what your home is worth on paper, and what is owed on it to the bank.
Unlike cash, home equity is an “illiquid asset”, which means that it can’t be readily accessed or spent.
All things equal, it’s better to hold liquid assets as an investor as compared to illiquid assets. In case of an emergency, you can use your liquid assets to relieve some of the pressure.
It’s among the reasons why conservative investors prefer making as small of a down payment as possible.”
As you can see, there are a wide variety of down payment options for buyers. Please feel to contact me to go over those choices, as it would be my pleasure to help you in financing your next home.