What Is a Down Cost on a House?
As you are preparing to buy a home – or at least start the process – you may have found that this is not the easiest way to navigate. Buying a home can come with myriad questions about interest rates, lenders, or even terms that will be used during the loan process.
It also includes questions about the down payment you need to pay for your home.
Using a mortgage calculator, you might have been able to work out the numbers and see if you scraped together enough cash to pay the down payment. However, that’s not the only factor in this equation.
How big or small a down payment is directly affects how much you pay for your home. It can even determine what type of loan you qualify for. Down payments are a big part of the loan process and you need to make sure you have your questions answered before making any decisions. If you’re unsure how down payments work when buying a home, it can really cost you.
What is a Mortgage Down Payment on a Home?
A mortgage down payment is a portion of the total cost of the home that the buyer pays when buying a mortgage loan. These upfront costs are a percentage of the total cost of the home and are paid upon completion.
The average down payment on a home is only 6% when averaged out first time buyers. This number is well below the recommended 20% deposit recommended for home buyers.
[ Read: Home Financing Guide ]
Most lenders have a minimum down payment requirement for every type of loan or financial situation. These requirements can be as little as 3% or much higher, but they depend on a number of different factors. It is important to know that the total amount you wager is yours as long as you set at least the minimum required by your lender.
For example, let’s say you want to buy a home priced at $ 200,000 and are considering saving 20%. You want to pay $ 40,000 upfront for your deposit. However, if your lender has a 5% down payment requirement, all you need to do is deposit $ 10,000. You can either pay the down payment of $ 40,000 or opt for an amount of $ 10,000 or more to meet the lender’s requirements.
Why do you need a deposit?
There can be some confusion as to whether or not you require a down payment when buying a home. It may not always be required by home buyers, but depositing money on a home can benefit both the buyer and the lender.
When homebuyers put money into their homes, they reduce their lender’s risk. Every time a lender approves a mortgage loan, they take a risk. Simply put, the higher the loan amount, the higher the risk. Your down payment will reduce the amount of money you need to borrow, which will lower the lender’s risk.
You may also benefit from paying a larger down payment in the form of a lower interest rate. Buyers with solid financial profiles that include a reasonable down payment are more likely to get the low interest rates offered by the lender because of the lower credit risk.
When you make a down payment, it also shows the lender you invested in on the property. This means that you are more likely to make timely payments for your loan. This could mean the difference between loan approval and denial if you’re about to be approved.
How a deposit can work in your favor
Finding the money to pay for a larger down payment can be a daunting task, but it can also work in the home buyer’s favor. You technically don’t own your home until you have paid back your mortgage loan. So if you put more money down, you will own more of your home. This is known as equity and it can work in your favor later as well. You can borrow when necessary and it creates wealth for you too.
It can also help you get approval for your loan. Your lender will take less money to buy the home, so you will improve your chances of getting a loan approved. If approved, this large down payment may give you a lower interest rate, saving you money by paying less total interest over the life of the loan. This could also result in lower monthly mortgage payments.
You can also avoid paying for private mortgage insurance (PMI) if you can raise enough money for a traditional loan. PMI is insurance that protects your lender – and is required for any borrower with a traditional loan that is less than 20% less. By saving 20% or more, you can avoid having this additional fee count towards your monthly mortgage payments.
Down payments for different types of mortgages
Your down payment will depend on the type of mortgage loan you plan to use. You can assume that your down payment request will average between 0% and 10%. The loans that do not require a down payment may have additional requirements that home buyers must meet to be eligible.
Federal Housing Administration loans, or FHA loans, are designed to have fewer requirements than traditional loans. That means home buyers with less than perfect credit or buyers with a higher debt-to-income ratio can use these loans to purchase single and multi-family homes. The down payment can be as little as 3.5% or 10% depending on the homebuyer’s creditworthiness and other factors.
[ Next: What are the Different Type of Mortgages? ]
It is important to note that these types of loans come with their own set of mortgage insurance premiums that are required from buyers regardless of the size of their down payment.
VA loans are loans for veterans, active members of the military, and surviving spouses interested in home buying. This type of loan does not require a down payment and you do not have to pay for additional mortgage insurance, but the home cannot be for more than the estimated value of the home.
USDA loans are generally for low and middle income buyers interested in buying a home to qualify for a rural area. This type of loan does not require a down payment, but it is much more difficult to obtain than some of the other types of loans.
Conventional mortgage payments
Conventional loans, on the other hand, are loans for which lenders set their own down payment requirements. These loans have a PMI for borrowers who don’t put a 20% stake, but it needs to be removed after you’ve built up 22% equity in the home.
For the most part, you need good credit, debt-to-income ratios, and a solid down payment to get a traditional loan. Your lender may have other requirements as well.
After the purchase of your home is complete, you need to start paying back your mortgage loan. You make monthly payments for a set period of time. The amount you pay each month is based on your principal, interest rate, and other applicable fees, including taxes, mortgage insurance, and escrow.
A certain formula is used to calculate the monthly payment: principal + interest + fees = monthly payment amount.
[ Read: How to Calculate Your Mortgage ]
In most cases, if your loan term on a traditional loan is 30 years, you will pay the same amount every month for the next 30 years.
In some cases, however, the monthly payment changes. This is the case when you have an adjustable interest rate that can fluctuate over the life of the loan. Depending on the interest rate, the monthly payment would be higher or lower than in the previous month.
A mortgage payment calculator can help you get a better idea of how much your mortgage loan is costing.
No down payment mortgages
It’s clear that a down payment will work in your favor, but does that mean a no-down mortgage will work against you?
Not necessarily. No down payment mortgages mean homebuyers don’t have to worry about their down payment because they don’t have to make any.
In the previous example, if the home you bought was $ 200,000 instead of paying a 5% down payment or $ 10,000, which would give you a loan with a principal of $ 190,000, you would not be putting money on this type of mortgage loan. If you choose a no down payment mortgage, you will receive a principal of $ 200,000.
While it sounds good not to have cash to pay for the down payment, there are ramifications in opting for a no down payment mortgage. If you opt for a USDA, FHA, or any other type of no down payment mortgage loan, you may face a higher monthly mortgage payment and interest rate. This also removes you further from owning your home as it will take you longer to repay your mortgage.
You also pay more interest overall because you borrow more money. You may be paying well in excess of what you would have originally needed for this type of loan.
Too long, not read?
There are different types of mortgage loans and the choices you have in a home purchase are countless. This includes loan options that do not require down payments that both the lender and the home buyer can benefit from. Down payments still have their perks, however – so don’t make any decisions without cracking the numbers and weighing the factors that matter to you.
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