Buying a house is one of the biggest financial decisions most people make in their lifetime. It’s also one of the most expensive purchases they’ll ever make. Therefore, it’s important to understand the costs involved and plan accordingly.
One of the biggest costs when it comes to buying a house is the down payment. The down payment is the initial payment you make towards the purchase price of the property. In this article, we’ll explore the minimum down payment on a house and what you need to know.
WHAT IS A MINIMUM DOWN PAYMENT?
When it comes to buying a house, it’s important to have a solid understanding of what a down payment is. A down payment is an upfront payment you make towards the purchase price of a property. It’s usually expressed as a percentage of the total cost of the house. The minimum down payment is the lowest amount of money you’re required to put down on a house.
The amount of the minimum down payment varies depending on several factors, including the purchase price of the property and the type of mortgage you choose. In the United States, the minimum down payment typically ranges between 3% and 5% of the purchase price of the property. It’s important to note that some lenders may require a higher down payment, especially if you have a low credit score or are considered a high-risk borrower. It’s always a good idea to speak with a lender to get a better understanding of your options and what you can afford.
IS A 20% DOWN PAYMENT REQUIRED WHEN BUYING A HOUSE?
No, 20% down is not required when buying a home, and the thought of committing to a 20% down payment can be daunting when taking on a new financial obligation. However, while it may appear to be a lofty objective for prospective homeowners, only a few lenders currently require it at the time of closing.
Although there are numerous advantages to making a 20% down payment, it shouldn’t be the sole factor preventing you from acquiring the home of your dreams. Remember, with proper research and planning, it is possible to navigate this process successfully and secure your ideal home.
WHAT ARE THE ADVANTAGES AND DISADVANTAGES OF PUTTING 20% DOWN?
Let’s take a look at some reasons why it may or may not make sense to put 20% down on your home purchase:
Advantages
No Private Mortgage Insurance (PMI)
Placing 20% down will negate the need for PMI, which is insurance that protects the lender if you default on the loan. Private mortgage insurance automatically drops within an average of about 7 years, but can take longer. Click here to learn more about Private Mortgage Insurance and how it works.
Better Interest Rates
If you put more money down when getting a loan, the interest rate is usually lower because the lender sees less risk. This means that for every 5% increase in the down payment, the interest rate generally gets better, up to 25% down if you have good credit, or 40% down if your credit is not so great. But that is not always the case, as a higher loan amount will sometimes come with a better interest rate, or less closing costs. Make sure to speak with your loan officer to determine which option is best for you.
Lower Monthly Payments
Who doesn’t like lower monthly payments?! The combination of no PMI, a lower interest rate, and a lower starting principal balance will reduce your overall monthly payment and free up cash for other expenses.
Disadvantages
Higher Risks
Once you have made a down payment on your mortgage, retrieving the funds is no easy feat. It is advisable to opt for a smaller down payment and establish an emergency fund if you anticipate the need for the money in the future. This way, you can avoid potential financial difficulties that could arise from tying up all your funds in your home.
Reduced Funds for Other Expenses
One of the downsides to placing a 20% down payment on a home is that it requires a significant amount of funds upfront. This can result in less money being available for other expenses, such as furnishings, renovations, or unexpected emergencies. Additionally, it may limit your ability to invest in other financial ventures that could yield a higher return on investment. Therefore, it’s essential to evaluate your financial situation and future goals carefully before deciding on the appropriate down payment amount.
Requires More Time To Save
Saving for a down payment is a prolonged process that can take months, years, or even decades for many individuals. Delaying your home purchase until you have saved enough for a 20% down payment may result in a significant opportunity cost, especially when considering the rent you will pay each month. In such cases, purchasing a home now may be more cost-effective in the long run than paying rent while you accumulate enough funds for a 20% down payment.
MINIMUM DOWN PAYMENT FOR DIFFERENT TYPES OF MORTGAGES
The minimum down payment on a house varies depending on the type of mortgage you choose. Here are some common types of mortgages and their minimum down payment requirements:
Conventional mortgage
The minimum down payment for a conventional mortgage is usually between 3% and 5% of the purchase price of the property. However, some lenders may require a higher down payment if your credit score is low or your debt-to-income ratio is high. First-time homebuyers may qualify for as low as 3% down.
FHA mortgage
The minimum down payment for an FHA mortgage is usually 3.5% of the purchase price of the property. However, you’ll also be required to pay mortgage insurance premiums (MIP) for the life of the loan.
VA mortgage
If you’re an active-duty service member or veteran, you may qualify for a VA mortgage, which requires no minimum down payment. Even if you’re non-exempt and have to pay a funding fee, it can be added to the financing. However, borrowers should still be prepared to pay closing costs, which typically amount to around 1% – 3% of the purchase price.
USDA mortgage
If you’re buying a house in a rural area, you may be eligible for a USDA mortgage. The minimum down payment for a USDA mortgage is 0%. However, you’ll be required to pay a guarantee fee, which can range from 1% to 2.75% of the loan amount.
Down Payment For A Vacation or Second Home
A second home refers to a property that an individual owns, which serves as a vacation home or an additional residence apart from their primary home. Unlike an investment property that is bought with the primary aim of generating rental income or profits, a second home is typically used for personal purposes such as recreational activities, family vacations, or as a retreat. The owner of a second home may use it periodically throughout the year or seasonally and may choose to rent it out when not in use to help cover the expenses of owning the property.
Conventional Loan
When purchasing a second home, the minimum down payment requirement is typically higher than that of a primary residence. While a 20% down payment is ideal, many lenders will accept a minimum of 10% down payment for a second home. This is due to the higher risk associated with a second home, as it is considered an additional property and may not be occupied as frequently as the primary residence. Additionally, the down payment requirement may vary depending on the lender, the borrower’s credit score, debt-to-income ratio, and the location of the property. It’s essential to conduct thorough research and consult with a trusted financial advisor to determine the best down payment amount for your second home purchase.
FHA Loans
Second homes are ineligible for FHA financing. Although, an FHA loan can be used to purchase a multi-unit primary residence.
VA Loans
Vacation homes are not eligible for VA financing. Click here to read about how you can purchase another property with a VA loan while already using VA entitlement.
Down Payment For an Investment Property
An investment property refers to a real estate property that is bought with the primary intention of generating rental income or reselling it at a profit. The property can be a residential or commercial building, a condominium, or vacant land that the owner expects to generate returns from rental income or appreciation in value over time. Investment properties are usually acquired by individuals or real estate investors who are willing to undertake the financial and management responsibilities involved in owning a rental property. The owner of an investment property may choose to hire a property management company to manage the day-to-day operations of the property, including tenant placement, rent collection, maintenance, and repairs.
Conventional Loan
When using a conventional loan to purchase an investment property, the down payment requirements are generally higher than for a primary residence. In most cases, a minimum down payment of 15-25% of the property’s purchase price is required. However, some lenders may require as much as 30% or more, depending on the borrower’s creditworthiness and the location of the property. The larger down payment requirement for investment properties is due to the higher risk associated with them. Investment properties are considered riskier than primary residences since the owner’s primary goal is generating rental income or profits from the property, rather than living in the home. As a result, lenders require a larger down payment to minimize the risk associated with financing such properties.
FHA Loans
Investment homes are ineligible for FHA financing. Although, an FHA loan can be used to purchase a multi-unit primary residence.
VA Loans
Investment homes are ineligible for VA financing.
THE BOTTOM LINE
Purchasing a house is a significant financial decision that requires careful consideration of the costs involved. One of the most substantial expenses is the down payment, which varies depending on the type of mortgage and the property’s location. While a 20% down payment is ideal, it may not be feasible for everyone. Opting for a smaller down payment can have its advantages, such as making homeownership more accessible and freeing up cash for other expenses.
However, it’s essential to weigh the pros and cons and plan accordingly to avoid potential financial difficulties down the road. Additionally, the minimum down payment requirements for second homes and investment properties are typically higher than those for primary residences. Conducting thorough research and consulting with a trusted financial advisor can help determine the best down payment amount for your unique situation.
