Homebuyers

Down Payments: What You Should Know

One thing on everyone's mind when looking to buy a house, especially first-time home buyers, is saving for a down payment. As it turns out, you may not have to save as much as you think to buy a house.

Luckily, we're here to clear up any misconceptions on how down payments work. Do you have questions? We have answers.

Let's start with the biggest question first.

What exactly is a down payment?

A down payment is a lump sum payment you make towards a large purchase, such as a house or a car. Down payments are often represented as a percentage of the total purchase price.

What is the purpose of a down payment?

Depending on what type of loan you choose you may be required to provide a down payment.

Many loan types may have loan-to-value (LTV) limits, while some do not. If the mortgage loan type you decide on does have loan-to-value limits, then you would be required to make a down payment. For example: If your purchase price is $200,000 and the loan-to-value limit on the mortgage is 80%, you would be required to make a down payment of 20% or $40,000. Fortunately, many types of mortgages require little to no money down.

Any down payment made is subtracted from your purchase price and the remaining balance needed to complete the purchase is the amount you would need a mortgage loan for. Your loan amount is then divided up into recurring monthly payments amortized over a certain number of years depending on your loan term and interest rate.

How much do you need for a down payment?

Not as much as you may be expecting. The common thinking is that you need to save up and provide a 20% down payment to buy a house, but that simply is not true.

In some cases, you may only be expected to provide a down payment of 3% of the loan amount. In other cases, you may not have to provide any down payment at all.

Different loan programs have different requirements. As such, mortgage lenders may require a down payment of between 3% and 20% to be approved for a home loan. It all depends on your credit score, your financial situation, and the loan program itself.

What should my down payment be?

You may be asking yourself: how much should you save for a down payment? Well, it depends on your unique situation and your financial goals. Often, you may be able to choose the amount of down payment to make, but this decision may not always be easy.

Some people believe a bigger down payment is better since that decreases the amount borrowed, which then decreases the monthly payment and mortgage interest paid over time. Others prefer a smaller down payment since that may be easier to achieve or they simply prefer to keep their savings on hand.

It all depends on your borrowing needs and your financial circumstances. Make sure you evaluate both the pros and the cons when making your decision.

With a bigger down payment, you will have a lower mortgage payment. The more you pay up-front, the lower the loan amount. There are also some additional benefits to making a larger down payment, which include:

• Lower rates – You may qualify for a lower interest rate if you put more down, which would decrease your monthly payment.
• Mortgage insurance – When buying a home, you may be able to skip the mortgage insurance. You may be required to pay mortgage insurance each month depending on the type of loan you are looking for and your loan to value.
• Lower monthly payments – By financing a smaller amount, your monthly payment may be lower, which could allow you to use the extra money on other things, such as home improvements.

A smaller down payment means you don't have to come up with as much money up-front, and this may have potential benefits which include:

• Buy sooner – Saving for a 20% down payment will likely take longer than a 5% down payment, for example. A smaller down payment may enable you to buy a home faster.
• Home improvements – By not providing a large down payment, you may have extra cash on hand to do a few home improvements and turn your new home into your dream home.

However, it's important to keep in mind that the minimum amount you will be required to provide will depend on which type of loan program you qualify for.

Can you buy a house with less than 20% down?

Absolutely. Several loan programs do not require a down payment of 20%, including:

• Conventional loans may require as little as 3% down. Conventional loans may include private mortgage insurance (PMI) if you do not provide a down payment of 20%. However, you will no longer be required to pay for PMI once you have reached 20% equity in the home.
• FHA loans require a minimum down payment of 3.5%. These loans are backed by the federal government and may be a good option for first-time home buyers, buyers with a lower credit score, or those with a challenging credit history.
• VA loans and USDA loans do not require a down payment, although eligibility for these loans is limited to certain individuals or certain geographical areas.

How to save for a down payment?

Now that we've discussed down payments and how they work, the next big question is how you're going to save up for your down payment. While down payments can seem like a challenge, they are really like any other goal you set for yourself, achievable.

To succeed, don't think only about the bigger goal. Break it down into smaller, more easily accomplished actions you can take to save money. You'd be surprised how quickly your savings can build up with just a handful of small changes to your life.

13 Things You Can Do to Help Reach Your Down Payment Goal

Here are 13 things you can start doing today that can help you reach your goal, perhaps even within a year.

1. Nickel and Dime Yourself

Look at your expenses and what you're spending money on. Then find opportunities to cut back. Consider cooking or preparing more of your meals yourself as opposed to getting takeout again. Also take a look at any recurring monthly expenses, like cable TV or streaming services, and consider what you may be able to live without. Small cutbacks can add up over time.

2. Set It and Forget It

Establish a high-yield savings account that is strictly for your down payment. You may even want to choose a bank that's separate from the one you normally use so you won't be tempted to dip into your savings. Then, schedule an automatic transfer that takes some money out of every paycheck and deposits it into that account.

3. Up Your App Game

Find an app that will help you save and visualize your progress. Visit your app store of choice and you'll find several personal financial apps that help you manage your money more efficiently. For example, you can set a weekly coffee budget and send the rest to savings when you come in under the amount.

4. Create a Waterfall

Concentrate on paying off high-interest debt, such as credit cards, one at a time. Once you pay one off, move to the next one. As you reduce your monthly debt payments, it should free up cash you can save for your down payment.

5. Get a Side Hustle

In today's economy, there are plenty of options for earning extra income outside of "traditional" business hours. Depending on what skill you have, there may be numerous freelance opportunities for you. Whether it's selling your knitted masterpieces online, driving for a ride-sharing service, or something else, divert the extra income toward your down payment.

6. Semi-retire Your 401K Contribution

Consider temporarily reducing your 401K contribution while you are saving for your down payment. Put aside the difference in your savings account until you've reached your goal. Once that happens, increase your contribution percentage back to at least what it was previously.

7. Think Smaller

If you can manage it, decreasing your current housing expenses may enable you to put more money away for a down payment. Moving to a smaller, less costly space for a short time can help you save money for a bigger, more permanent place to call home.

8. Ask to See the Benjamins

Include your relatives and friends in your savings goal. When a gift-receiving opportunity presents itself and you're asked what you'd like for the occasion, answer, "Cash, please!"

9. Plan a Staycation

While it may seem very tempting considering the circumstances of the last year, instead of splurging on an expensive vacation this year, challenge yourself to find as many fun —preferably inexpensive and free — things as you can to do and see in your hometown. With each ticket you don't buy or restaurant meal you don't pay as much for, you can add the amount you saved to your savings account.

10. Hold a Real (or Virtual) Yard Sale

Do you have a bunch of stuff gathering dust? Well, they say one person's trash is another person's treasure. Letting go of those skis that you haven't used in five years will be easier if you know that the money you make from selling them will go toward a new home. Many online marketplaces make it easy to get your merchandise in front of potential buyers. Plus, it means less stuff to pack and move when the time comes!

11. Stash Your Raise

Congratulations! Your hard work over the past year was recognized. Now, pretend it never happened. Instead, continue to live off the amount of your old paycheck and put the remainder in your down payment savings account.

13. Save that Tax Refund

If you receive a tax refund or any other sort of financial windfall, put that money into your separate down payment savings account. It may be tough to deny the urge to splurge, but it's important to remember that you are saving for something important and potentially life-changing.

13. Look at All Your Options

The government may offer down payment assistance for those who qualify. Many cities, counties, and states also have down payment assistance programs. Do your research as taking advantage of one of these programs could greatly reduce the amount you'll need to save and stretch the dollars you have accumulated.

Now that you've learned about saving for a down payment, what happens when it's time to put your down payment savings to use? Let's take a quick look.

Is the down payment due at closing?

Yes, the down payment is due when the loan closes, but people don't always provide it in one large payment.

In some cases, people may split their down payment into two pieces. The first payment is made after they sign the purchase contract and deposit a designated amount of funds in escrow until the purchase is ready to close. A second payment is made at the time of loan closing. In some cases, those who are selling their current house and buying a new house may be able to use the proceeds of the sale as a down payment towards their new home.

With many loan options available, don't let a down payment stand between you and your dream home.

If you're having trouble saving for a down payment, you should know that New American Funding has loan programs and down payment assistance programs that you could qualify for. Make sure you speak with a New American Funding Loan Officer to learn your options and don't forget to use our mortgage calculator to estimate your monthly payments.