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Down payment on a house: What is it and how it works

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    One of the major steps toward homeownership is saving for a down payment. It’s an upfront, lump sum payment that covers part of a home purchase, and a mortgage typically covers the rest. The amount someone spends on their down payment depends on the house they’re purchasing and their mortgage type. And it can also have an impact on their mortgage terms, such as interest rate and the requirement of mortgage insurance.

    So, there may be a lot to consider when thinking about how much money to put down on a home. Let’s look at what exactly down payments are and how they work in the homebuying journey.

    What is a down payment?

    A down payment is the money you pay up front toward the cost of your new home or property. It reduces the amount of money you’ll need to borrow to purchase the home. Depending on the lender and type of loan, a minimum mortgage down payment can range from 3–20% of the home purchase price. It’s a common misconception that 20% is necessary for a down payment. In fact, the National Association of Realtors (NAR) reports an average down payment of about 6%. There are also programs available, if you qualify, that may allow you to put down little to no money.

    Does your down payment affect your interest rate?

    Yes. The interest rate is the cost of borrowing, stated as a percentage, charged by a lender on the principal amount of your mortgage. This is the rate your monthly payment is based on. Typically, the larger the down payment, the more competitive the interest rate. That’s because this typically leads to a lower borrowed amount, which may cause the lender to see it as being lower risk. It helps to bear in mind, however, that lenders may also consider the current real estate market, the type of mortgage and other details surrounding the borrower’s financial profile when determining rates.

    Down payments and mortgage insurance

    Depending on the size of your down payment, your lender may require you to pay mortgage insurance in addition to your interest — this is where people typically confuse the 20% rule. If you can put down 20% as a down payment, then you can typically avoid paying private mortgage insurance (PMI). If you put down less than 20%, your lender may require PMI. Once you reach 20% equity in your home, you may be able to refinance and remove PMI or you can request from your loan servicer to remove PMI.

    Similar to your mortgage terms, your PMI rates are heavily affected by your credit score and how much you put down.

    Mortgages that may not require a down payment

    There are a few government-backed mortgage options that accept little to no down payment on a home, but they may be more difficult to obtain. For example, some VA and USDA loans may allow for little-to-no down payment, but these mortgages have strict qualifications.

    VA loans

    VA loans are backed by the U.S. Department of Veterans Affairs, and they’re for current or past service members and eligible spouses. A down payment is not required, and there are no monthly Mortgage Insurance fees that may be typically required for certain conventional mortgages..

    USDA loan

    According to the official website for the U.S. Department of Agriculture, if you qualify under the Direct Loan program, no down payment is required. Also, applicants may be eligible for payment assistance, which subsidizes the interest portion of the mortgage, lowering the overall monthly payment.

    Down payment myths

    The common misconceptions surrounding down payments discourage people from becoming homeowners. Despite what you may have heard, down payments can be flexible, making homeownership a likely reality for people. Here are some common misconceptions:

    • Myth: You have to put down 20%. Like previously stated, you don’t need to put down 20% on a home to be able to qualify for a mortgage. However, lenders may require PMI if you put down less than 20%.
    • Myth: Down payment assistance programs are meant for first-time homebuyers only. Although many down payment assistance programs do have this requirement, this isn’t true for all. Some programs may require that you haven’t purchased a home in the last few years, rather than never having purchased a home.
    • Myth: The down payment and closing costs are the only costs associated with buying a home. Though the down payment and closing costs are two of the key payments when buying a home, there are other associated costs, including appraisal, inspection and loan application fees.

    In summary

    A down payment is the upfront, lumpsum payment made to a seller through an escrow account when purchasing a home. The difference between your down payment and the home’s selling price is typically your mortgage amount. Note that your down payment impacts your mortgage terms, specifically your interest rate.

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