How big of a down payment do I need?

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How big of a down payment do I need?

By JOHN KUO

When buying a home, you typically pay a part of the home's purchase price in cash. This is known as the down payment, while the mortgage is a loan that allows you to pay off the rest of the home's cost over time. So if you want to buy a $250,000 home, you might pay a $50,000 down payment and borrow $200,000 from a mortgage lender.

In this example, the down payment works out to 20 percent. Conventional wisdom says you should have a down payment of at least 20 percent in order to buy a home, because most lenders consider mortgages with smaller down payments a little too risky for their tastes. But is that really true?

Not necessarily.

A 20 percent down payment may help you avoid extra costs such as private mortgage insurance (PMI), which some lenders require to protect themselves if you don't repay your mortgage loan. But the size you'll be required to put down may depend on other factors.

What are my down payment options?

Your down payment may depend, first and foremost, on the type of loan you choose. Kathryn Bishop, a real estate agent based in Studio City, California, recommends asking your lender to help you find the best loan type for you.

"The lender may be able to tell you which loan programs you qualify for and how much each program requires for a down payment," Bishop says. She notes that the loan programs available to you may vary according to your income, emergency savings, credit score and current down payment saved.

As you shop around for mortgages, be sure to tap resources besides your real estate agent and lender. They will be knowledgeable, but they also have a skin in the game. You should also check out objective government entities, such as the Consumer Financial Protection Bureau.

Loan types are typically split between conventional loans and loans insured by government programs. Here's what that breakdown looks like:

Conventional loans

Conventional home loans are loans not insured by the government. They're usually offered by banks and other mortgage lenders. Homebuyers typically pay 5-20 percent down for conventional home loans, though there are some conventional loans with down payments as low as 3 percent. Buyers who pay less than 20 percent typically must pay for private mortgage insurance.

Federal Housing Administration (FHA)

To encourage homeownership, the FHA provides mortgage insurance to private lenders to protect against default from riskier buyers.

FHA loans allow for lower credit scores and smaller down payments (as low as 3.5 percent) than most conventional mortgages. However, they're generally more expensive than conventional loans because the cost of mortgage insurance is passed on to the borrower. If you have good credit and qualify for a conventional loan, you might want to avoid FHA loans because your interest payments will likely be more expensive in the long run.

According to Steven Ho, vice president and senior mortgage lending officer at Quontic Bank in Astoria, New York, FHA loans can be a good choice for first-time homebuyers.

"Homebuyers looking for a low down payment might benefit from an FHA loan," Ho says. "First-time homebuyers, in particular, are often interested in this type of loan because using gift money from someone else may be allowed for all or a portion of a down payment and/or closing costs."

Veterans Affairs (VA)

VA loans give veterans and their surviving spouses favorable terms. The U.S. Department of Veterans Affairs helps guarantee the loan. Qualified applicants can often pay 0 percent down without paying for monthly mortgage insurance. However, generally all borrowers must pay a funding fee at closing time.

U.S. Department of Agriculture (USDA)

The USDA guarantees loans with 0 percent down payments for low- and medium-income homebuyers in rural areas. USDA borrowers will have to pay mortgage insurance and an upfront fee.

How much should I put down?

20 percent

Most of the mortgages in the U.S. are guaranteed by Fannie Mae and Freddie Mac. These two government-sponsored companies require borrowers to put down 20 percent or else pay for PMI. By putting down at least 20 percent, you'll save money each month because you won't have to pay for PMI.

Less than 20 percent

If you put down less than 20 percent for your home, you can expect mortgage insurance payments each month until your mortgage balance reaches 78 percent of the original value of your home (though you can request that your lender cancel the PMI when the balance falls to 80 percent). A smaller down payment also means that you're borrowing more money. Since it costs money to borrow money, you'll end up seeing larger monthly interest payments for your mortgage.

The Consumer Financial Protection Bureau provides a great example of the varying costs of different down payments. As the infographic illustrates, the larger your down payment, the lower your overall costs. Not everyone can afford a large down payment, but it's important to know what you're getting into and what your costs might look like down the road.

More than 20 percent

If you can afford more than 20 percent for your down payment, congratulations! By putting at least 20 percent down, you won't be required to pay PMI. You may be tempted to put a 40 percent down payment on your home or even pay full price in cash upfront, but that might not be the best idea. As financial columnist Robert Pagliarini writes in the Chicago Tribune, financing your home may come with added benefits such as mortgage interest deductions and real estate leverage.

Bottom line

The size of your down payment may greatly impact your loan costs, so if you haven't already started saving for your home, there's no time like the present. Keep in mind that government programs will sometimes give you favorable terms, so you should ask your mortgage lender if you qualify.

About the Author: John Kuo is a personal finance writer living in Northern California. He writes about mortgages, small businesses and taxes. His work has been featured in numerous outlets such as The Washington Post and The Wall Street Journal. In his free time, he likes to play bocce ball and paint.

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