Down payments are something that need to be fully understood before purchasing a home. How much does the down payment need to be? Where can it come from? Read on for answers to these questions and more.
- First off, what are down payments? A down payment is money that a buyer puts down toward the purchase of a home. The money may not be paid all at once though; some of it may be in the form of earnest money, which is paid by the buyer when the contract is signed to show the seller they are serious about buying the home. The rest of the down payment will be paid at the time of closing.
- How much needs to be put down? Down payments for a FHA loan are generally 3.5% for a 30 year fixed mortgage while conventional loans typically require at least 5% down.
- Down payments of 20% or more allow the borrower to avoid mortgage insurance, or PMI (private mortgage insurance). PMI will be paid monthly for down payments less than 20%. A conventional loan will require PMI to be paid until there is 20% equity in the home. When the loan amount goes below 78% of the mortgage, the lender is obligated to stop the mortgage insurance.
- What happens if earnest money is paid but the buyer is no longer interested in the home? When earnest money down payments are made, there is normally an inspection contingency where the buyer can walk away from the deal during the inspection time and get a full refund of the earnest money they paid. Although the cost of the inspection won’t be returned, it’s a better option than purchasing a home that may have costly issues.
- What about getting help with down payments? Many home buyers, especially first time home buyers, will get assistance from family and friends with their down payment. That is OK, but it’s not as straight forward as just getting the money and buying the home. The friend or family member will need to write a letter to the mortgage lender explaining how much the gift amount is, the date the funds were given to the home buyer, a statement explaining that the money given is in fact a gift and they do not need to be paid back, and other items as well. This signed letter will need to be given to the lender and will be handed over to the underwriter(s) for the loan. Underwriters need to ensure that the money is definitely a gift versus a loan to the borrower. If the loan is FHA, the person gifting the down payment money must also provide a copy of their bank statement along with the letter explaining the details of the gift.