Down payments play an important role in the home buying process; they impact the type of mortgage you qualify for, how much you will borrow, and can influence your interest rate. They can also set you apart from other buyers. But if you’re a first-time homebuyer, you may be wondering what exactly a down payment is and how much you need. Read on to learn more.
What is a down payment?
The down payment is the cash deposit paid towards the purchase of a home. It’s typically expressed as a percentage of the total purchase price. The remaining balance of the purchase price is covered by a loan secured from a lender. The larger the down payment, the less you need to borrow to cover the remaining purchase amount.
How do down payments work?
The down payment is the amount you’ll pay upfront, usually in cash. Lenders will take your down payment and subtract that from the final purchase price of the home to determine how much you’ll need to mortgage.
Once your offer has been accepted, a portion of your down payment will be deposited into a trust or escrow account that will be paid out at closing. This is called your earnest money or good faith deposit. The remainder will be due right before closing.
It’s important to know that your down payment is separate from the closing costs. Depending on your negotiated offer, you should expect to pay an additional 2-7% of the final purchase price.
What are minimum down payment requirements?
Some first-time buyers are surprised to find that 20% is not the minimum down payment amount. In fact, the average down payment for first-time homebuyers is 6% and 16% for repeat home buyers.
The minimum down payment required depends largely on the type of loan you get. Your lender may set a minimum down payment requirement so check with them for exact figures.
How much should your down payment be?
The size of your down payment is up to you as long as you meet your lender’s minimum requirement. Deciding how much your down payment will be can be difficult. Some people remain laser-focused on putting down 20% or more. Others are fine with a smaller down payment if that means they’ll have more in reserves for contingencies or emergencies. There are some pros and cons for both options that must be carefully considered.
Pros of larger down payments
There are several benefits of having a larger down payment:
- Smaller mortgage: the more you put down, the less you need to borrow. This means you’ll pay less in total interest over the life of your loan and lower monthly payments.
- Lower rates: you may qualify for a lower interest rate if you have a larger down payment. Down payments reduce lenders’ risk of default so they sometimes pass that reward onto you.
- Avoid mortgage insurance: if you’re able to put down 20% or more, you’ll be able to avoid purchasing private mortgage insurance and other fees.
- Potential equity: larger down payments mean you’ll begin building equity sooner. Equity is the amount of your home you actually own.
Pros of smaller down payments
Even smaller down payments have their benefits. These include:
- Buy sooner: it can take several years to save the 20% for a new home purchase. Smaller down payments mean you can get into home ownership sooner.
- Emergency reserves: if the idea of putting down that large chunk of money makes you a little nervous, consider setting aside some of that for an emergency fund.
- Improvement funds: small down payments mean you’ll have additional funds to cover the cost of improvements and repairs without having to wait to rebuild your savings.
How to determine your down payment
The size of your down payment is highly personal and unique for each homebuyer. The ideal amount will depend on your financial situation and goals. Follow these steps to determine how much home you can afford and a down payment amount.
- Create a buying timeline: your timeline for buying a home will determine how long you have to save. If you want (or need) to buy sooner rather than later, a smaller down payment will make that possible. Likewise, if you don’t have a pressing deadline and can afford to wait, use that time to save for a larger down payment.
- Evaluate your budget: lenders will provide an estimated budget range when you apply for a mortgage preapproval. This number may be different from how much you’re comfortable spending and that’s okay. You don’t need to borrow the full amount. Review your current budget to determine how much you’re willing to spend.
- Use a mortgage calculator: mortgage calculators are a great way to see how your down payment will affect your monthly mortgage payments. This will help you determine if the proposed payments will fit in your budget.
Saving for a down payment can feel overwhelming but it doesn’t have to be. With a bit of homework, you can create a savings strategy that can have you in a new home on your schedule.
We build new homes throughout the Bay Area that are perfect for families of all sizes, whether it will be your first home or your forever home. Visit us online at DiscoveryHomes.com to learn more about your new home communities, view virtual tours, and more. We look forward to welcoming you home.