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Home down payments: Everything you need to know

Here's how to determine the right amount to put down on your future home.

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Get ready to lay down some cash!

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You're about to embark on the exciting journey of becoming a homeowner. But before you start house hunting, you've got to work out a budget, which starts with securing financing and figuring out your down payment amount. 

The good news is that with rates at historic lows, it's a killer time to shop for a mortgage and buy a home.

The down payment is the amount you pay upfront, your so-called skin in the homebuying game. Here's what you need to know to start figuring out what the right down payment amount is for you. 

Why do you need a down payment?

Most lenders require you to make a significant payment upfront as part of securing a mortgage. Depending on your income and credit history, as well as the type of mortgage and a lender's specific requirements, you can expect to make a down payment that's between 3% and 20% of the purchase price.

The bottom line: The more you put down, the less you have to borrow -- which may help you snag a lower interest rate and reduce your total loan cost. 

Down payment requirements

The specifics of a down payment depend on a range of factors, including the particulars of your financial background and any special requirements from your lender. That noted, each type of mortgage has its own set of rules.

Conventional mortgages: With conventional mortgages, your lender determines your down payment. Typically, you can make a down payment as low as 3% to 5%. With conventional mortgages, if you do not make a down payment of 20%, you will have private mortgage insurance. Lenders can add the PMI to your monthly premium. 

FHA loans: Your down payment for an FHA loan depends on your credit score. You could have a down payment as low as 3.5% if your score exceeds 580. If it doesn't, your down payment will be 10%. 

VA loans: VA loans are for military personnel and veterans, provided they meet the criteria. You can view all the eligibility criteria on the Department of Veteran Affairs' website. If you do qualify for a VA mortgage, you do not have to make a down payment. 

USDA loans: With USDA loans, you do not need to make a down payment. However, you do need to meet eligibility requirements to qualify. 

Fannie Mae HomeReady: With Fannie Mae, you could have a down payment as low as 3%. The HomeReady program suits those with lower income who have a credit score of at least 620, though if you have a score above 680, you could receive better rates. 

Freddie Mac Home Possible: The program gives homeowners a chance to qualify for a down payment as low as 3%. It's perfect for first-time homebuyers, seniors or those wanting to upgrade to larger homes. 

Benefits of a large down payment

A larger down payment can give you more equity from the start. Think of it this way, if the purchase price is $200,000 and you make a $40,000 down payment, your mortgage will be only $160,000, giving you up to 20% equity off the bat. It helps you avoid private mortgage insurance and lowers your monthly payment relative to making a smaller down payment. It will also save you money in the long run because you will not have to pay interest on that $40,000.

Here is an illustration of what your payments look like when making a 3.5% down payment versus a 20% one on a 30-year fixed-rate mortgage:

Down payment types, compared

Purchase price Down payment amount Percent down Interest rate Monthly principal and interest Total monthly payment with insurance and tax
$200,000 $7,000 3.50% 3% $813 $1,281
$200,000 $40,000 20% 3% $674 $1,142

While the $139 difference might seem negligible on the surface, consider that you're saving over $100 a month for 30 years. In turn, that represents a savings of up to $50,040, making the initial investment of 20% well worth it. 

How much of a down payment should you make?

While your lender sets requirements as to what you must pay to receive mortgage approval, you can put more down if you want. It's vital to budget beforehand to ensure the down payment you want to make will not infringe on your other financial goals. 

Also, you can use a mortgage payment calculator to determine different down payment amounts and how each influences your monthly payment. Using this tool can help you determine the right fit for your financial needs. 

How to save for a down payment 

"Saving for a down payment is really about putting a plan together and following it," says Michigan-based Jason Gelios, the author of Think Like a Realtor.

"Hitting your target savings amount could be as simple as getting a side gig, asking for a gift from family (provided the loan allows this), cutting out unnecessary items from your daily or monthly spending and finding additional ways to increase your income," he says.

Other sources you could use to fund your down payment include selling assets like cars, valuable artwork or jewelry. You can also borrow money from your retirement account -- if your broker allows it. However, if you do not repay the loan within the time allotted, you could face expensive tax liabilities. 

When you are ready to make a down payment, you must show proof of how you received it. Mortgage lender Dan Green, whose company Homebuyer is aimed at first-time buyers, recommends "keeping a proper paper trail because mortgage lenders examine banking deposits for fraud and money laundering. For deposits they cannot verify, they will not be able to apply towards the purchase of a home."

There are also down payment assistance programs available to help homebuyers, though you will have to meet income, residential and other requirements to qualify. 

Pitfalls to avoid

Meanwhile, there are methods you want to avoid when putting together a down payment as well. To start, you don't want to drain your savings account to make the down payment. For one, it does not leave you with anything in reserve: If a surprise expense comes up, then you might have to put it on credit.

And two, other costs arise from home ownership. You have closing costs, home appraisal fees and expenses associated with moving and furnishing your new place. Therefore, it is imperative to strike the right balance between making a healthy down payment while leaving plenty in the bank to account for other expenses.

Something else to avoid is using high-interest debts to fund your down payment. Taking out a mortgage is a tremendous financial undertaking on its own, but adding high-interest debt on top of that does not give you as much financial wiggle room. Furthermore, because the debt is high interest, it will take you longer to repay the loan -- at a much higher expense. 

Why do mortgage lenders require a down payment?

"The point of a down payment is it gives the borrower some skin in the game, and helps ensure the lender will be able to recoup its money in the event the borrower doesn't pay," says Matt Frankel, a CFP and mortgage analyst with The Ascent. "A buyer who just paid $50,000 out of their own pocket towards a home purchase is more likely to try to avoid foreclosure than one who didn't pay anything at all."

Overall, while the down payment is a critical part of the process, there are other factors you should consider as part of the big picture. Green suggests, "Spend less time planning for a down payment, and more planning a monthly budget. The down payment is a one-time event. The mortgage payment is ongoing."

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