When borrowing money in the form of a loan, you may often need to make a down payment that covers part of the purchase price. This is almost always a given in the world of Real Estate.
This initial payment can be crucial to your borrowing costs over the life of your loan, and greatly affect your chances of getting approved. Let’s read a bit more about how down payments work.
What is a down payment?
A down payment is an upfront payment you make to purchase a home, vehicle, or another asset. The down payment is the portion of the purchase price that you pay out-of-pocket. That money typically comes from your personal savings, and in most cases, you pay with a check, a credit card, or cash.
You might sometimes see a loan being featured as “zero down”, which means you do not have to put any money down.
How much should you pay?
Real Estate professionals will encourage you to put at least 20% down. However, there are pros and cons to large and small down payments.
- Larger down payment – A big down payment means lower interest rates, smaller monthly payments, and reduced mortgage insurance costs.
- Smaller down payment – A smaller down payment helps you to buy a home sooner rather than later, gives you more funds for repairs and renovations, and allows you to keep extra money in your savings for emergencies, investment accounts, or retirement down the line.
Lender requirements
Do not be surprised if a lender sets a specific down payment requirement.
Paying at least 20% allows you to avoid paying for PMI, which protects your lender if you default on the loan. If you can’t bring 20% to the table, an FHA loan might be a viable option, requiring only 3.5% down. However, you still pay for insurance with an FHA loan, and you need to evaluate whether or not you’re in a good position to buy if you’re short on funds.
VA loans typically require no down payment and offer reduced closing costs.
The alternatives
If you are applying for a construction loan, a lien on your land might act as a down payment.
Also, government professions such as teaching, and first responder jobs have access to special assistance and loan programs.
You can also accept a down payment gift from relatives. Read more about how down payment gifts work here.
