Things to Know About Making an FHA Loan Down Payment

Many first-time homebuyers need some help understanding and navigating the ins and outs of the mortgage process, and down payments are an essential part of that. A down payment is an upfront installment (typically a higher amount) made on a large purchase while the remainder is paid off with a loan. Before deciding how much or how little you want to put down on your new home, it is helpful to understand a few key factors: 

Lenders Need to Mitigate Risk 

Making a sizeable down payment gives lenders peace of mind, knowing that a borrower would not part with a large amount of money if they did not intend to come through on the entire loan. Depending on the type of mortgage you apply for, the down payment requirement may vary. For most conventional loans, borrowers are generally required to pay 20% of the purchase price, whereas FHA loans have a low requirement of 3.5%. FHA-approved lenders feel more comfortable accepting this smaller amount since the loans are insured by the FHA, and the lenders are protected in the case of borrowers defaulting. 

Private Mortgage Insurance  

Even though most conventional loans come with the 20% minimum down payment criteria, there are borrowers who cannot meet that requirement. This does not always exclude them from being approved. In the same way the FHA charges a Mortgage Insurance Premium with their loans, conventional mortgage lenders require that any borrowers paying less than 20% toward the down payment must purchase Private Mortgage Insurance (PMI).  

If you are considering a conventional mortgage, it is important that you understand how Private Mortgage Insurance works. While it helps you qualify for a loan that you could not otherwise afford, it does increase the cost of the loan itself. You can make a lower payment upfront, but the monthly PMI premium will be added into your monthly mortgage payments. Additionally, PMI does not protect you, it protects the lender from losses if you are unable to pay back the loan. In most cases, you will not have to make PMI payments for the life of the loan. Pertaining to the conventional loan, once you have built up more than 20% equity in your home, you can put in a request to have the monthly PMI charge dropped. Talk to your loan officer to make sure this is an option before you sign! 

Down Payments and Interest Rates 

While the amount of money you put down on a home may not affect the interest rate you receive from the lender, it does impact the amount of interest you pay over the life of the loan. Making a larger down payment means paying less in interest, since you are borrowing less money. Imagine that you are buying a $200,000-home with a down payment of $20,000. You would be paying interest on a $180,000 loan. (200,000 – 20,000). Whereas if you paid only $10,000 upfront, you’d be paying interest on a $190,000-loan instead. 

Down payments are one of the most daunting factors of homebuying for many first-time buyers. Saving up such a huge chunk of funds is not always an affordable option for most people, and so they get stuck in a “renter’s trap.” While it can be a little overwhelming, it’s important for prospective homebuyers to do their research and learn about their options, including Down Payment Assistance Programs. Head to www.fha.com to for a comprehensive list of programs for each state.

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