You likely know that you have to get a mortgage to purchase a home. Understanding down payment, however, is a bit more challenging.
When you purchase a home using a loan, you will usually be required to make a down payment. Without it, you likely won’t get approved, and this can affect the interest payment and the amount of the loan later on. Because of this, understanding down payment is really important for any future homeowner.
Here are five facts you need to know about down payment:
1. What Is Down Payment?
A down payment is a payment you make upfront when you plan to purchase a house (or some other asset, such as a vehicle). While this seems clear, understanding down payment isn’t as clear.
Down payment usually comes from your personal savings, and, apart from the amount, it has little to do with the loan itself. Usually, you can pay with a credit card, a check, or even an electronic payment.
Down payments are usually an important part of obtaining a loan. However, some ‘zero down’ offers exist, even when you’re purchasing a house. Once you pay the down payment, you can go and pay the rest of the loan monthly, unless you refinance your mortgage or pay the loan off earlier than necessary.
2. How Much Is the Down Payment?
Usually, you can choose how big of a down payment you want. While some general rule is that the down payment should be 20% of the full home price, this can be flexible, depending on the type of mortgage you’re getting. Usually, though, you can choose whether you want this amount to be higher or lower, but both have their pros and cons.
Why You Should Pay a Larger Down Payment?
When it comes to understanding down payment, you need to know why you might want to consider paying a big down payment.
Overall, a bigger down payment means a smaller mortgage. This makes sense: The more you pay in advance, the less will remain for the borrowing. As a result, you’ll have smaller monthly payments and smaller interest rates. Also, by paying a 20% down payment, you might avoid paying for private mortgage insurance and a few other additional fees. A large down payment will also let other lenders know that you’re a serious customer as you’ll have a decent debt-to-income ratio.
Why You Should Pay a Smaller Down Payment?
Of course, it’s important to realize why some people choose to pay less for your understanding of down payment. The main good side is quite straightforward: You’ll pay less money at once.
When buying a house, it can take you years to save 20% of the home price. This isn’t always acceptable. Not to mention that a large down payment might leave you without your emergency reserves. Not to mention if you’ll need cash for some emergency upgrades or repairs!
3. Is a 20% Down Payment Required?
Many lenders will set a minimum required down payment – but there’s nothing stopping you from paying more if you’d like. Most lenders require a 20% down payment, but you can get a ‘better’ deal. Still, it’s usually smarter to pay as large down payment as possible, for all the reasons we’ve counted. If anything else, almost no one wants to get stuck with paying PMI!
4. Are There Alternatives to Cash?
Usually, lenders require cash for a down payment, but this can also be a check, wire transfer, and money order. Many people on their journey to understanding down payment want to know whether there are some alternatives, and fortunately, there are. For example, if you’re applying for a construction loan, land can serve as a down payment.
5. Is the Down Payment the Same as the Closing Costs?
When understanding down payment, you need to realize that down payment and closing costs are two entirely different things. Down payment is necessary to ensure your loan. Closing costs, on the other hand, cost an additional 2%-7% of the entire price, and they can be paid by either the home seller or home buyer.