How to Determine Your Down Payment on a Home

There’s a lot to learn when you’re in the market for a new home, from deciphering the documents you’ll be signing to figuring out all the financial aspects of buying a home. One of the biggest parts of getting a new home is figuring out the terms and conditions of your mortgage. Two major influencers of this are your credit and your down payment. In this article, we explain how you can determine the down payment on a home you’ll potentially be purchasing.

What Is a Down Payment?

When someone buys a home, it’s common for them to provide some of their own money upfront (separate from what they’ll pay each month on their mortgage). This money serves as the down payment for the home. Many buyers find that coming up with a down payment for a house is the most challenging aspect of the home buying process. It’s a good idea to examine your finances early so you have a better idea of what you’ll be able to pay. There are plenty of online tools, including this handy one on Credit.com, that allow you to see how much of a home you can afford based on your down payment and other factors.

It’s important to note that the more money you put down upfront, the lower your monthly mortgage payments will be. Many home loans require a specific down payment that’s typically equal to 3% to 20% of the sales price of the home. There are 0%-down loans available, but they narrow your home options, as fewer lenders are willing to lend to homebuyers who opt out of a down payment.

Your Credit Scores

As we mentioned earlier, besides your down payment, your credit scores play a role in your mortgage. (Not sure where your credit currently stands? You can view two of your credit scores for free on Credit.com.) Your credit history and debt in relation to your total assets can also affect how much you’re able to borrow and whether you qualify for different types of home loans.

The Impact a Down Payment Has on Buying a Home

The main reason down payments are so expensive is because lenders typically require them before approving your home loan. These are some other ways your down payment impacts your home buying experience:

• The larger your down payment, the less you’ll have to cover with a mortgage, and therefore, the lower your monthly loan payments will be.
• If you have a very small down payment, you’re likely limiting the number of mortgages you’re eligible for, and may be charged a higher interest rate on those you do qualify for.
• On the flip side, the more you can put down, the more mortgage options you’ll have.
• For any down payment less than 20% of the asking price, your lender may ask you to also pay Private Mortgage Insurance (PMI).
• Lenders sometimes allow sellers to cover less of the closing costs when a buyer has a very small down payment.

The down payment can also act as a reality check. If you haven’t been able to save even a minimal down payment of 3% to 5% of the price of a house you’re considering, it’s wise to ask yourself whether you’re financially ready to buy a home. Reflect on why you haven’t been able to save, and think about whether you’d be able to keep up with your mortgage payments, assuming you could find full financing. While it might be stressful to continue renting instead of buying, you may want to think of it this way: Renting for a while longer will be less stressful than losing your home to foreclosure because you were unable to pay the mortgage payments.

Can I Buy a Home With a Small Down Payment?

A limiting factor for many homebuyers is the lack of an adequate down payment, and in the wake of the financial crisis, there are fewer lenders offering 100% financing. Having a small down payment is typically better than none at all, but of course neither of those options is ideal. So, how can you buy a home without a significant down payment? Here are a few options to consider if you find yourself in this situation:

• Focus on Saving More

If you have a good debt-to-income ratio (income compared to your current debt obligations), maybe consider saving more. Many people can easily handle the debt they have but think lenders want them to be completely debt-free before applying for a mortgage, which isn’t necessarily the case. The general rule of thumb is that your debt-to-income (DTI) ratio should be 43% or less, though some lenders may give you a mortgage if your DTI is more than that. (Note: This does not mean you should avoid paying off debt or skip payments altogether.)

• Look Into 100% Financing

Another type of home loan is the 100% financing home loan — meaning, your mortgage covers the entire cost of purchasing a home, eliminating the need for a down payment. While this may sound ideal, you’ll still need to pay the closing costs, have to pay PMI and have much higher monthly payments than you would if you made a down payment.

The Federal Housing Administration, the Department of Veterans Affairs and the United States Department of Agriculture all offer 100% financing loans you may want to consider. Just keep in mind that the interest rate for these loans may be higher than the rates for other loan options.

• 80/10/10 Loans

Another option is a “piggyback” transaction. This essentially means you’ll get your main mortgage for 80% of the price of the home, make at least a 10% down payment, and take out a second home loan to cover the other 10%. You’ll also be required to pay closing costs with this option and PMI is not typically required.

• Be Sure You’re Ready

There are programs to help you if you don’t have a substantial down payment. These programs will help you secure loans but not make your monthly payments. Be sure you’re financially ready to do so on your own before taking on 100% financing.

Receiving Money from Friends or Family

Many homebuyers receive money from friends or family to buy their house. If this is the situation you’re in, you need to distinguish the money as a gift instead of a loan, or lenders will view the money as debt. This record is not hard to create — your relative, friend or whoever gifted you the money typically needs to write a letter indicating the money is a gift, not a loan. You may want to talk with your lender or financial adviser about this decision to make sure you’re following the proper procedure.

Remember Additional Costs

While it’s a good idea to make a large down payment on a house, you don’t want to overspend there either, as there are other expenses you’ll face with buying a house. Closing costs, moving costs, repairs to the new home, new furniture needs and other costs should also be taken into consideration when budgeting for your new house.

Hannah Maluth contributed to this article. This article has been updated. It was originally published November 17, 2016

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