Unless you have a big stash of cash, you’ll need to borrow money to buy a home. Oh, you’ll still need some cash (for the down payment and closing costs), so don’t stop socking it away just yet.
In fact, one of the things that confuses our clients most is the down payment they’ll pay when they get a home loan. So, today we’ll share some of the questions we most frequently field.
Why do I have to make a down payment?
Not all home loans (also known as “mortgages”) require a down payment, but most do. There are several reasons for the requirement. Primary among them is that the money helps protect the lender in case you default on the loan.
Secondary to that is the fact that lenders understand that borrowers with “skin in the game” are more apt to do whatever it takes to hang on to the home and not allow the loan to go into foreclosure.
Is the down payment the same as the earnest money I give the seller?
No. The earnest money’s purpose is to show the seller that you are earnest about buying the home. The amount varies and it is typically held in a broker’s trust account or in escrow until either the purchase is finalized or you or the seller back out of the transaction.
When the purchase is finalized, the earnest money deposit is credited toward your down payment or, in some instances, closing costs.
The purchase contract contains what are known as “contingencies.” For instance, your purchase may be contingent upon you obtaining final loan approval. Should this not come to pass, you can walk away from the purchase with a full refund of your earnest money deposit.
If, on the other hand, you get cold feet and walk away from the deal, the seller may have the right to keep the deposit.
I’ve heard that some sellers help pay the down payment. Is that true?
No, it is not true. Sellers cannot help the buyer with the down payment. On the other hand, they are allowed to contribute toward the buyer’s closing costs.
You can, however, use gifted funds, as long as the money doesn’t come from someone directly involved in the transaction. The person who gifts you the funds must be able to document where the money came from.
If the gift funds are undocumented, you’ll need to have them in your bank account for at least 60 days before the lender will consider them “seasoned.” In fact, even your own down payment funds must either be sourced or seasoned, so if you need to move money around, do it as soon as possible.
Can I use money from my retirement account to pay the down payment?
Yes, you can, but we urge you to speak with your financial advisor or accountant before doing so. There may be penalties or tax ramifications that you should consider.
You’ll find information on borrowing money from your 401k at smartasset.com and moneycrashers.com. You’ll also find an article about why it isn’t a good idea to withdraw retirement funds for a down payment at kiplinger.com.
Again, we urge you to speak with a financial advisor before making the decision.
How much will I need to pay for a down payment?
How much you’ll be required to pay for a down payment depends on the loan product you’re using. The U.S. Department of Veterans Affairs and U.S. Department of Agriculture loan programs require no down payment but each has specific eligibility requirements.
Other loan programs, such as those offered through FHA and Fannie Mae and Freddie Mac offer low down payments and the range is generally tied to credit scores. With a conventional loan, you’ll typically be expected to pay 20 percent of the loan amount for the down payment.
If it makes sense, you might want to consider voluntarily paying a larger down payment, if it’s within your budget. The more you pay, the smaller the loan amount will be and, thus, the smaller your monthly loan payment will be.
Make a down payment that nets you 20 percent equity in the home, and you won’t be required to purchase private mortgage insurance, which adds a hefty premium fee to your monthly house payment.
When is the down payment due?
While you will need to show the lender proof of your funds for the down payment, the actual monies aren’t due until closing.
The lender will send you a form, called the “Loan Estimate.” While it breaks down all of the costs associated with the loan, pay special attention to the “Costs at Closing” section, specifically the second line under that heading, “Estimated Cash to Close.”
You’ll find a sample Loan Estimate online at consumerfinance.gov.
This amount reflects how much you’ll need to provide to your lender before the transaction is closed. It includes the down payment and closing costs and the lender typically requires the funds be in the form of a cashier’s check or wire transfer.
Please don’t hesitate to reach out to us if you have additional down payment questions or to clear up any confusion on other real estate-related topics. We’re happy to help.