Everything You Need to Know About Your Down Payment
As you consider how much money to put down on a home, here’s what you should keep in mind…
What is a mortgage down payment?
It’s the cash a home buyer puts toward a mortgage loan at closing. The down payment represents a percentage of the home’s purchase price. A mortgage professional provides the rest of the money needed to buy a home, which the borrower repays with interest over a set term.
A mortgage down payment often impacts the loan amount, interest rate, monthly payments, mortgage insurance requirements, and loan approval terms.
How the Down Payment Affects Your Mortgage Rate
The higher the down payment, the lower the Loan-to-Value (LTV) ratio. A lower LTV usually gives mortgage professionals confidence that there’s less risk of default on a loan. Often, the less risky the loan, the better the interest rate for the borrower.
Depending on factors including market conditions, a down payment of more than 20% could lower the rate between 0.25 and 0.75%.
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How much do you need for a down payment?
Twenty percent has been the rule of thumb in the U.S. for nearly a century. However, most homebuyers make lower mortgage down payments. Today’s first-time home buyers usually put down 8% on average. Repeat buyers typically put down 19% on average.
Many mortgage programs require down payments below these averages. Conventional mortgages generally ask for a minimum of 3% to 5% down. FHA loans require a minimum down payment of 3.5%, while VA loans may require no down payment.
Down Payments for High-Value Homes
Jumbo loans (for amounts that exceed conforming loan limits) typically require down payments of between 10% and 25%. A higher dollar amount and lack of government backing make them riskier loans.
Jumbo loans can have higher rates than conventional mortgages, but usually have comparable rates for well-qualified buyers.
Using Cash for Your Down Payment
In banking and finance, “cash” often refers to money in a checking or savings account. Cash equivalents, such as Treasury bills and money market funds, are assets that you can easily convert into cash.
Can you use cash not in a bank for a down payment? Probably not. Most mortgage professionals will want to see documentation showing where the cash came from. Most people who want to use cash without such documentation usually deposit the money in a bank. In that case, you can expect a 60-day wait for bank statement reviews.
Gift cash is common. Recent data from the National Association of Realtors shows 25% of first-time home buyers with mortgages use cash from family or friends to help with the down payment. While there’s no limit to gift cash, you normally have to document the money and provide statements from donors.
What financial assets can be used for a down payment?
Many people who sell one home use their proceeds for the down payment on another. It’s better to sell first; sellers usually receive funds from a home sale on closing day.
You can sell stocks, bonds, mutual funds, and other equity assets to cover a down payment.
There are two ways to use your 401k:
- You can withdraw money from your 401k. If you are under 59 ½, you typically pay a 10% penalty on the amount you withdraw. The money you withdraw is considered taxable income.
- You can borrow against your 401k. Here, you basically lend money to yourself. You can borrow up to 50% of your 401k balance up to $50,000 and repay the loan plus interest in monthly installments.
You can also use an IRA. First-time homebuyers can make penalty-free withdrawals from traditional and Roth IRAs up to $10,000. That amount, for example, could cover a 3.5% down payment on a FHA loan of $285,000.
What about cryptocurrency? You’ll need to convert crypto to dollars, and a mortgage professional may require a 60-day seasoning period. Keep in mind that converting crypto triggers capital gains taxes.
Is there financial assistance for down payments?
Yes. Especially in the case of first-time and low-to-moderate income home buyers. Across federal, state, and local entities, the U.S. has more than 2,000 programs to help with down payments and closing costs. To find a program, begin with this down payment assistance tool.
The Pros and Cons of Larger Down Payments
Pros include:
- Bidding advantage. When bidding against other potential home buyers, a sizable down payment (shown in a mortgage pre-approval letter) could distinguish you as the preferred bidder.
- Borrowing power. Having more money invested in a home usually means more borrowing power. This could be useful if you wish to do a cash-out refinance, a home equity loan (HELOAN), or a home equity line of credit (HELOC).
- Insurance savings. With more than 20% down, you may not need Private Mortgage Insurance (PMI) on a conventional mortgage.
- Loan approval. A substantial down payment often improves the chances of loan approval.
Cons include:
- Depleted savings. You don’t want to drain your bank account and be unprepared if life throws you a costly curveball.
- Rising costs. While you’re saving for a down payment, home prices and interest rates could rise. That could cost you more in the long run.
The Pros and Cons of Smaller Down Payments
Pros include:
- Expediency. By not spending time saving for a large down payment, you may move into a home faster.
- Cash cushion. You could face home repairs or need emergency funds. Holding back a cash reserve might make financial sense.
Cons include:
- Higher monthly cost. Less money down means a higher monthly mortgage payment.
- Higher overall interest. A smaller down payment means you borrow more money and pay more interest over the life of the loan. That could add up to tens of thousands of dollars over a 30-year mortgage.
Weighing short-term affordability against long-term savings, your down payment size directly impacts your mortgage terms.
Still unsure about the right down payment for you? We can help you with tailored home financing options that fit your specific needs. Call us at 1-888-505-8960 or connect with us online today.