Lack of savings and the inability to outlay any cash for a down payment continues to be the biggest hurdle facing first time home buyers. Unfortunately, many would-be buyers incorrectly assume they must come to the closing table with a hefty amount of money, and as a result, they continue to delay homeownership.
Yes, lenders love to see buyers put 20% down, but they also know that amount of money is very difficult for first-time buyers to amass. Just to give you a baseline, in 2018, the median down payment was 13% for all buyers and 7% for first-time buyers, according to the National Association of Realtors.
So if you’re considering buying your first home but stopped your search when you came across the term ‘down payment,’ you’ll be interested to learn about the many programs available to buyers. But before we explore the different down payment programs available, let’s back up and understand what a down payment is and how it works.
What is a down payment?
A down payment is the amount of money you put down upfront towards the total purchase price of your home.
For example, let’s say your purchase price of your new home is $250,000. If you want to put 5% down (down payments are always expressed in percentages) you would be responsible for coming up with $12,500. The remaining purchase price would be financed through your lender.
Advantages of a 20% down payment
You’ll avoid Private Mortgage Insurance (PMI)
Buyers who take advantage of low down payment mortgages are often hit with PMI. PMI exists to protect the lender in the event that the borrower defaults on the loan, and is typically .3 to 1.5 percent of the original loan value.
You’ll have instant equity in your home
The more you put down up front, the more equity you’ll have in your home from the beginning. For example, if you choose to put 20% down on a $300,000 home you’ve already got $60,000 in equity right off the bat!
You’ll have a lower monthly payment
A lower monthly payment means you can likely comfortably save for unplanned expenses and not be strapped for cash when your a/c gives out in the middle of July.
Disadvantages of a 20% down payment
You might drain your savings
The down payment isn’t the only expense you’ll be feeling when you purchase a home. Homeowners insurance, closing costs, inspections and property taxes all come due, too. Additionally, you’ll likely be purchasing furniture, or making updates or enhancements to your new space that will all require cash. You’ll also want to save about 2 percent of the purchase price of your home each year for unplanned expenses like replacing the water heater or servicing the a/c unit.
You might delay homeownership
Coming up with 20% as a first-time home buyer is tough and may mean you have to rent longer. In the long run, buying a home is still a better investment than renting.
Can I use gift funds to cover my down payment?
Yes, but there’s one caveat, gift funds must truly be “gift” funds and not a loan disguised as gift funds.
Many first-time buyers use gift funds to secure their first home. If you’re using gift funds to buy your first place here’s some things you’ll need to know:
- If you’re financing the remainder of your home’s purchase price via a conventional loan or VA loan the funds can only come from an immediate or close family member.
- On the other hand, if you’re financing through an FHA mortgage you have more options as to where the gift funds can originate:
- Family/extended family
- Labor unions
- Government agencies
- Nonprofits that provide assistance to first-time home buyers
*Make sure to check with your lender about gift funds coming from your employer or a labor union.
- You’ll need to obtain a gift letter to provide to your lender. Include your gift donor’s name and gift specifics— exact gift amount, date of money transfer, and the address of the home you intend to purchase with the funds.
Loan choices available with little to no down payment
Conventional loans: 3 percent down
Available through Fannie Mae and Freddie Mac, these government-backed loans offer borrowers some pretty appealing mortgage options. Qualified buyers can purchase a home with as little as 3 percent down thanks to the good folks at Fannie and Freddie.
FHA loans: 3.5% down
FHA loans are often the best option for first-time buyers. Less than stellar credit and not a lot of cash up front? FHA loans are your saving grace. Home buyers that go through FHA to finance their home are able to do so with as little as 3.5 percent down.
VA loans: 0 down
For members of the military, veterans, reservists and National Guard, loans backed by Veterans Affairs can be obtained without any down payment. PMI or private mortgage insurance that is typically required for loans obtained without a minimum down payment of 20 percent is not required with VA loans— another huge plus.
USDA loans: 0 down
Backed by the United States Department of Agriculture, eligible rural and suburban home buyers can qualify for zero down payment loans with low interest rates. If the hustle and bustle of big city living has never been your scene, sit down with a lender to check and see if the home you’re interested in meets USDA criteria.
Go with a down payment you can afford
In the end, let your budget guide you when deciding how much down payment to put down on your home. If it makes sense to stick to a month mortgage amount of $1500, but only putting down 3% means you’re on the hook for $2,000 every month, it might be a good idea to save up for a few more months before you decide to buy.
Keep in mind too, it’s a good idea to save between 1 and 3 percent of your home’s total purchase price for unplanned expenses, so make sure to factor that into your budget, as well.
All of these dollar signs starting to make you feel dizzy? Don’t get light-headed— making mortgage payments each month as opposed to rent payments dramatically increases your overall wealth in the long run. With each payment you make you’ll be reducing the balance on your mortgage while simultaneously building equity on your investment— and if you’re smart, your investment is likely to pay off big time come retirement.