Ups and downs of down payments

Prospective home buyers often cite the down payment as a significant hurdle to their home-buying plans. The first step to jump over that hurdle is to examine the alternatives and come up with a down payment goal that makes sense for your personal situation.

A "down payment" is a chunk of the home purchase price that the buyer pays in cash, instead of financing. The amount is usually expressed as a percentage. For example, if you borrowed $190,000 and paid $10,000 cash to buy a $200,000 home, the $10,000 would be your down payment. To figure out the percentage, divide the down payment, $10,000, by the price, $200,000, and you’ll get the answer, in this case, 5 percent.

The down payment, which does not include closing costs, becomes a financial cushion, called "equity", in your home. Equity can help you build wealth or you might be able to borrow against it in the form of a home equity loan or line of credit.

Larger down payment avoids mortgage insurance
Years ago, lenders almost always required a down payment of at least 20 percent for a home purchase. Today, 5 percent-down loans are commonplace and 3 percent-down loans also are available. Some people even buy a home with no down payment.

Lenders are willing to offer these low-down and zero-down loans due to the availability of mortgage insurance, an added monthly charge that you pay to insure your lender against the risk that you might default on the loan. To avoid paying this extra charge, you’ll need to make a down payment that’s larger than 20 percent or you’ll need to consider a financing package that’s more complicated than one plain-vanilla mortgage.

Benefits of a larger or smaller down payment
A larger down payment not only avoids mortgage insurance, but also means your monthly mortgage payments will be lower than they would be if you borrowed a bigger percentage of the same purchase price. If the value of your home appreciates over time, your down payment could be a good investment compared with other investment opportunities. And if you’re buying a home in a competitive market, a larger down payment might make your purchase offer more attractive to the seller.

A larger down payment can result in a lower interest rate on your mortgage if it keeps your loan amount below the limit for a "conforming" mortgage. The conforming loan limit is not a percentage, but rather a specific amount that’s set annually in the secondary mortgage market and that varies among geographic areas. Ask your mortgage broker or lender for more information about the conforming loan limit.

A smaller down payment might help you purchase a home sooner because you might not need as much time to amass a smaller amount of money. Some buyers choose to make a smaller down payment so they can set aside money to furnish their new home or make repairs or improvements.

Sources of down payment funds
There are many ways prospective home buyers can start saving for a down payment. Home buyers can rely entirely on personal savings or the sale of personal assets to get a down payment or they can turn to other sources of funds as well. Examples include loans or gifts from family members, loans against an investment portfolio or retirement account, and government- or employer-sponsored home-buying programs. These sources of funds typically involve a lot of restrictions and rules, so be sure to do your homework before you make a decision.

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