Plenty of myths circulate about the home buying process. With conflicting pieces of information flying all over the neighborhood, how are you supposed to know what to believe? It’s time to provide some clarity about one of the more misunderstood parts of buying a home: The down payment.
If you’re a first-time homebuyer, you might not know exactly what a down payment is. It’s the initial payment you make when you purchase your house. It helps offset the lender’s risk and is just a portion of your home’s purchase price. Typically, a down payment is made in cash at your closing. And while your credit score impacts your interest rate and ability to get a home loan, it does not directly affect your down payment.
You might have several questions about down payments, but it’s likely that one stands above all: How much do I need to put down? A wide variety of answers exist, but the “golden rule” benchmark is 20 percent.
Now let’s get to debunking some of the most common myths about down payments.
Myth #1: You must put down 20 percent of your home’s purchase price.
While 20 percent is considered the “golden rule” for making a down payment on a home, it’s not a requirement written in stone. In fact, depending on your lender, your down payment could be much lower. For instance, mortgage programs such as Federal Housing Administration (FHA) loans, which are backed by the federal government, accept down payments as low as 3.5 percent. So, if you’re a first-time homebuyer (or any shopper, really) and haven’t quite saved up enough for 20 percent, fear not.
There is one caveat, however. The smaller your down payment is, the bigger risk you are to a lender. If you don’t put down a full 20 percent, you could be required to purchase private mortgage insurance (PMI), which protects the lender in case you default on your loan.
While PMI will cost you extra (an upfront charge as well as a likely monthly fee), making a smaller down payment could be a smart move if you prefer to keep more cash in reserve. The key is to make sure you settle on a down payment that’s the best fit for your financial situation.
Myth #2: It’s unnecessary to put down more than 20 percent.
If you have the money on hand, it can be beneficial to pay more up front. The larger your down payment, the less you’ll have to borrow, and the lower your monthly mortgage obligations will be. While putting down more than 20 percent might feel like a big sum, you could actually save money on the interest costs through the years.
But is that larger initial payment really worth it? Turns out, it could be. According to Investopedia, if you have a 30-year fixed mortgage with an interest rate of 5 percent, putting an extra $10,000 into your down payment will save you $9,325 in interest costs.
Paying less in interest isn’t the only benefit. Check out these additional potential benefits:
- Lower upfront and ongoing fees
- Lower monthly payments
- More home equity from the time you open your new front door
Having a less expensive monthly house payment is particularly helpful if you think you might need to borrow money for, say, a car or to pay for higher education, at some point down the road. It’ll give you some breathing room in your budget, so you can add another monthly payment without significant financial stress.
Myth #3: Money you borrow can be used for a down payment.
Even flexible lenders usually do not accept borrowed money as a down payment on a home. Getting a little financial help is not off the table, though. As long as money is gifted (think: from your parents, an aunt you’re close with), you can put it toward your initial payment. Just be prepared to provide confirmation to your lender that the givers won’t be asking for the funds to be repaid.
Myth #4: If you don’t have a lot of money for a down payment, you’re out of options.
It’s not the end of the world if you want to purchase a home but don’t have as much saved as you would have liked. The U.S. federal government offers various programs to help people in their quest for home ownership, such as Federal Housing Administration (FHA) loans and certain mortgage offerings (like those from Fannie Mae and Freddie Mac) that require a down payment as low as 3 percent.
If you’re a veteran, a family member of a veteran, or a rural borrower who meets certain income guidelines, additional mortgage options are available through the Department of Veterans Affairs (VA) and the USDA. These loans can offer down payments as low as 0 percent down, plus additional benefits.
Unlike conventional loans, borrowers that participate in these federal lending programs do not have to get PMI. That being said, FHA and USDA loan holders are required to get mortgage insurance. Instead of purchasing it from a private insurer, borrowers pay insurance premiums directly to the FHA or the USDA.
Take note: With traditional loans, you can cancel PMI once the balance of your mortgage equals 80 percent of the home’s appraised value at the time of purchase. But with these alternative loan options, the insurance expense lasts the life of the mortgage—meaning that you could end up spending more in the long run.
Myth #5: The down payment is the only money you need at closing.
In addition to your down payment, you’ll be responsible for additional closing costs. These fees typically run between 2 and 5 percent of the purchase price of your home and are often paid at the time of closing. (Some lenders allow you to roll them into your total loan amount. Do that, and you’ll pay interest on them.)
Closing costs include fees paid to your lender, like discount points, the origination fee, and sometimes application fees or a processing fee. You’ll also be charged fees by third parties to cover the costs of the appraisal, property survey, title search, insurance, attorney, credit bureau, flood certification, tax certification, and recording/state fees.
If you haven’t put 20 percent down, you might have additional fees such as mortgage insurance. It’s likely you’ll also have to make a payment into an escrow account. Your lender will use the funds in escrow to make property tax and homeowners insurance payments on your behalf.