10 Things to Know About Down Payments
Conventional wisdom says you need 20 percent of a home’s selling price to put down in order to purchase it. That's not the case (especially for first-time homebuyers), though it’s still considered a best practices suggestion, if possible. According to the National Association of Realtors, more than 70 percent of first-time homebuyers made down payments of less than 20 percent in the last five years. A total of 54 percent of all buyers made down payments of less than 20 percent. There are a lot of things to know to understand a down payment. Near the top of the list is understanding what a down payment actually means.
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What is a Down Payment?
A down payment is the first money that a buyer puts toward the purchase of a home but it might not come all at once. Part of that money might come when you sign the contract and another portion will come at closing. The first lump of money is considered earnest money because it shows you are serious about purchasing the house. It is also considered a contract deposit and goes into an escrow account, which is held by the seller’s lawyer.
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Know How Much You Have to Put Down
The minimum down payment you need to buy a home is 3.5 percent with a FHA loan on a 30-year fixed mortgage. Conventional mortgages require slightly more, typically about 5 percent. The Veterans Administration allows no money down financing for U.S. military veterans only and the U.S. Department of Agriculture loan programs allow no money down financing as long as the home is in a rural area and you meet the low-income thresholds. Find out other secrets of home buying.
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Putting 20 Percent Down Lets You Avoid Mortgage Insurance
If you want to avoid additional bills, plan on putting down at least 20 percent of the price of the home. If you put less than 20 percent down, you’ll be required to pay mortgage insurance. Mortgage insurance is often called PMI, or private mortgage insurance, and paid monthly. For a conventional loan you’ll have to pay mortgage insurance until you have 20 percent equity. When the loan balance dips to 78 percent of the mortgage, the mortgage provider is required to drop the mortgage insurance. Federal Housing Administration loans require mortgage insurance be paid for as long as the loan is in place for loans taken out after June 2013. You can make monthly mortgage insurance payments, a one-time payment, or have the lender pay the mortgage insurance if you agree to a higher interest rate. The last option will keep your monthly payments lower than if you paid PMI at one time but you’ll have to pay on the insurance until you repay the loan or refinance. If you want to stop paying mortgage insurance quicker there are a few routes. An appraisal might raise the value of the home and you could meet the 20 percent threshold. Making additional loan payments will increase your equity as well or you can remodel your home to increase the value. Also, find out how to save on home insurance.
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Understand Inspection Contingencies
Even if you’ve put down earnest money, in most cases, you’re able to walk away with a full refund during the inspection period. You’ll be out the cost of the inspection ($300 – $600), but it’s much cheaper than being stuck with a house with a bunch of problems. Be prepared for later steps in the process by knowing what to look for in a home inspection.
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Pre-Qualified vs. Pre-Approved: What’s the difference?
If you're serious about buying a home and not just trolling the market, be sure to get pre-approved by your bank or credit union before you start viewing homes. Also, be sure to obtain pre-approval instead of just pre-qualification, which is simply a preliminary letter from your bank without the official credit check, etc. With pre-approval, you will really feel ready to make an offer when a home feels right and if there's heavy competition you'll also know exactly what you can afford, which is really the most important thing. Consult these 10 things to know about buying a house.
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Getting Help With Down Payments Requires Extra Steps
Many first-time homebuyers are going to get some help with that down payment. Don’t expect a gift from a family member to suffice. Mortgage lenders will want to see the color of your money. Your friends or family will need to write a gift letter to the lender that explains the nature of the gift, along with the date the funds were transferred, a statement saying no repayment is expected and the donor’s signature, among other items. Underwriters want to make sure the sums of money are actually gifts and not loans. For a FHA loan, the donor will also be required to provide a bank statement on top of the letter. A down payment of 20 percent can be made up entirely of a gift, but anything less than 20 percent, a portion of the down payment must come from your own funds. For help picking that perfect home for a DIY-er, check out this advice.
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Be Prepared for Additional Closing Costs
Additional costs during closing can include things such as inspections, loan origination fees, and title insurance, so keep those in mind when putting together your down payment. The additional costs right at closing means it might make sense to put less money down in order to pay for the added expenses. Often closing costs are paid by the seller, but in competitive markets, it’s becoming more common for the costs to be split with or paid by the buyer.
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Know the Perks of Being a First-Time Homebuyer
There are a number of incentives out there for first-time homebuyers, especially if they meet certain income requirements. Some are at the federal level, state level or the local level. Sometimes communities offer money while the FHA allows a tax credit to pay for upfront home-buying costs. The Mortgage Credit Certificate Program provides up to a $2,000 tax credit per year for up to 30 years. It also includes a monthly payment loan for down payment and closing costs where the borrower will make monthly payments for up to 10 years. Know what to fix in your new home.
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Learn the Loan-to-Value Ratio
The amount of your down payment gives lenders the loan-to-value ratio of the property. It’s one of the main factors lenders consider when deciding to extend credit. If you're buying a property for $200,000, and you put down $40,000, your loan to value ratio is 80 percent. The higher the ratio, the riskier a loan is considered by the lending institution. After you've got that all figured out, start researching how to fix things around the house.
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Consider Your Cash Reserves
If you’re planning to do some work to the house right away or within the first six months, weigh the pros and cons of having some cash ready to do some work versus putting it all into the down payment (especially with mortgage rates still at historic lows). As you decide how to approach the down payment, try to avoid these home buying mistakes.
Originally Published: December 13, 2017