Down payment — two words that are ubiquitous with homebuying. It’s often assumed their meaning is common knowledge. Part of the homebuyer dogma that lives in hearts and minds of the homebuying hopeful. Something you intuitively know and understand. Right?
Okay, so maybe things aren’t that straight forward.
The truth is, buying a home is stressful enough without having to pretend that you’re going into it as an expert. Whether you’re a seasoned pro or a complete newbie, you can always learn more by asking questions, like these.
What is a down payment? And how much do you need for one?
Simply put, a down payment is a percentage of your home’s purchase price that you pay up front when you open a home loan.
The amount depends on the purchase price of your home, as well as the type of loan you choose. A common homebuying myth is that you must put down 20% of a home’s price, whether you’re getting a fixed-rate or adjustable-rate mortgage. (If you’re buying a $200,000 house, that’s a down payment of $40,000.) You have options for how much you put down, so choose an amount that works with your homebuying budget. With Ally Home, you can become a homeowner for as little as 3% down through the HomeReady mortgage program.
Note: Jumbo loans often have less flexibility and may even require you put up to 30% down. Ally Home requires jumbo loan borrowers to make a down payment of 20%.
What are some ways you can source a down payment?
You have several options when making a down payment:
- Gifted Money – Unlike borrowed money, gifted money does not require repayment and won’t affect whether a lender approves you for a mortgage. Depending on the amount, you may need to provide proof the money does not need to be repaid.
- Tap into retirement funds – First-time homebuyers may choose to tap into a Traditional IRA, up to $10,000 without being subject to the additional early distribution tax, to make a down payment. Keep in mind that every situation is different. You should always consult a tax professional before withdrawing retirement funds to determine the best choice for your situation.
- Down payment assistance programs – If you’re a first-time homebuyer, you might qualify for financial support from a government agency or private organization, like a nonprofit. Payment assistance may be available via grants, forgivable loans with 0% interest, matched savings programs, deferred-payment loans with 0% interest, or low-interest loans. Amount and eligibility requirements vary, but are usually based on your income, credit history and location.
What should you avoid when sourcing a down payment?
When it comes to buying a house, some of the more typical sources of cash are off limits, including:
- Personal loans – Generally speaking, personal loans are not allowed. Using borrowed money to make a down payment puts the lender at higher risk.
- Borrowing money from family and/or friends – The key word here is “borrowed.” If you have to pay it back, lenders are going to see it as additional risk.
- Credit cards – Aside from most credit limits not being high enough to cover a down payment, home sellers and lenders do not accept credit card payments directly.
You may be wondering why borrowed funds are prohibited. It’s because borrowing down payment funds increases your debt-to-income (DTI) ratio. Ideally, lenders like to see mortgage borrowers have a DTI of 36% or less.
What if you don’t have enough to put 20% down?
If your down payment is less than 20% of your purchase price, odds are your lender will require you to pay for private mortgage insurance (PMI). Don’t worry, it’s not as scary as it sounds. PMI gives you the ability to purchase a home even if you can’t make the traditional down payment of 20% of purchase price. In return for a lower down payment, PMI protects the lender if you are unable to make your mortgage payment.
PMI payments can be included in your monthly mortgage payments, so you don’t have to worry about making a separate payment. Once you have 20% equity in your home, you can request to cancel coverage, or your payments will automatically stop once you have 22% equity.
If you’re saving money for a down payment, where’s the best place to keep it?
If homeownership is a future dream you’re saving for today, you’ll want to keep your money somewhere low-risk, like our Ally Bank Online Savings Account. In addition to earning a competitive rate, you can use our Buckets tool to divvy up your down payment funds from your other savings goals.
Down Payments on the Up-and-Up
Understanding your down payment options shouldn’t be a hurdle when it comes to buying a home. Having the right knowledge can save you some time, money, and make you a homeowner sooner than you may have imagined.
A modern mortgage experience simplifies buying.