When you get a mortgage to purchase a home, the lender uses the lower of the agreed-upon purchase price or the property's appraised value to determine your maximum loan amount. The loan amount divided by the property home price equals your loan-to-value ratio, or LTV. That ratio is one of the major factors that lenders use to set your mortgage rate. If your LTV exceeds 80 percent, you'll probably be required to pay mortgage insurance, which increases your monthly payment. If the property appraises for less than the agreed-on purchase price, you are not usually required to complete the purchase.
A down payment is the difference between a home’s purchase price and the amount of the mortgage against the property. The down payment must be paid upfront before the home purchase can close.
The down payment requirement depends on the type of mortgage the home buyer chooses. Here is a partial list:
Down payments can only come from approved sources. Examples of approved sources, depending on the program, are:
Down payment help from parties that benefit from the property sale is not allowed. For example:
Down payment funds must be documented to prove that they come from an approved source. That can include bank statements, deposit slips, gift letters stating the funds need not be repaid, bills of sale and other paperwork.
In the context of home buying, a down payment of 20 percent or more of the purchase price can keep you from having to pay private mortgage insurance, or PMI. Private mortgage insurance may require an initial premium payment of 1.0 percent to 5.0 percent of your mortgage amount, as well as an additional monthly fee depending on your loan's structure. PMI protects lenders from losing money if borrowers default or fails to repay their debt.
Down payments can also help make your monthly payments manageable. Generally, the larger your down payment on a home or a car, the less you will have to pay each month. This can help you stay within your monthly budget so that you can save and invest money as you please.
If you don't have a great deal of money for a down payment on a home or a car, consider your options. There may be mortgages available that allow you to make low down payments, as well as plans that allow you to have two mortgages so you can avoid having to pay PMI. If your savings are low, but you are interested in buying, you might want to look into special government programs that allow first-time home buyers and veterans to purchase with little or no down payment. And if you need to get a car, you can consider a leasing plan if you can't make a substantial down payment.
Regardless of your down payment situation, be sure that whatever kind of loan you get is one you can manage. Work out the numbers and determine if waiting and saving more for a down payment can help you meet other financial goals, or if using what you have on hand for a down payment is right for you.