You DON’T have to put down 20% to buy a house… and other down payment facts

 

So, you want to buy a house, the only real rent control, but the thought of saving up 20% of the purchase price is… daunting? In the Denver market, the average home price eclipsed $500,000 last year. And… that would mean… you would need an extra $100,000 lying around to buy a home, right? Wrong.

Depending on the types of loans that you qualify for, you can purchase a home for as little as, well, nothing.

Other loans that are more broadly-available can get you into a home for 3% of the purchase price. It goes up from there.

So, why does everyone think you need 20% of the purchase price to buy a home?

This is usually considered the best case scenario when buying a home because with 20% down, you do not need to pay that additional monthly fee that everyone hates, Private Mortgage Insurance, aka PMI. 

However, sometimes it makes more sense to lock in a home price by purchasing it sooner rather than waiting until you have saved up 20% for a down payment. In a strong seller’s market, home values increase at a rate that is faster than most people can save (or make) money. In other words, in the time it takes you to save $60,000 for 20% down on a $300,000 home, that same home may have gone up in value by $100,000. So by taking the time to save $60,000, you lost $100,000 in equity opportunity. Makes sense? In market conditions like this, you can buy sooner with less than 20% down and then refinance 1-2 years later to ditch your PMI, like our client Maria did.

Down Payment Deep Dive

So now that I have handily dispelled that 20% down payment myth (I hope), I’d like to shed light on some other conversation topics and misunderstandings around down payments.

Won’t you join me on this #downpaymentdeepdive? Let’s start at the beginning, shall we?

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What is a down payment?

The down payment is the money that you pay out of pocket to buy a home. It is paid at closing, after all inspections and other contingencies have been met. (Ok. some of it is paid in the form of earnest money, but that’s a topic for another post. To be completely clear, because this comes up a lot, your earnest money goes towards your total down payment.)

The rest, the amount you don’t pay out of pocket, is the mortgage (loan).

The down payment does not include other expenses associated with buying a home like inspections, appraisal, closing costs, new furniture, change of address cards, new wreath for your front door, sage burning to purify the space a-la Roman Roy, you get the idea.

Why do I need a down payment?

In most cases, the lender will require a down payment. The rationale is that your investment reduces the lender’s risk because:

1. Borrowers who have invested in their house are less likely to default on their loan (i.e. stop making the mortgage payments).
2. If the lender has to foreclose on the property they will lose less money.
3. It is thought that the discipline and budgeting required to save a down payment is likely to prepare a homeowner for the responsibility of owning a home and making regular house payments.

These theories don’t always hold water. Not everyone budgets and saves for their down payment, for example. But, it’s the system that we’re working with. 

 

When is my house down payment due?

The down payment is due on closing day, after all inspections have been completed, contingencies met, and your loan has been approved. It is typical for the closing/contract  process to take about a month but, depending on the loan and other factors, it can take as little as 2 weeks. It can also take way longer. Just depends on all the variables- what you need, what the seller needs, what the lender needs.

You can get the funds to the title company via wire transfer or by certified check. Personal checks and ACH payments are not considered “good funds” for closing. I usually advise my clients to wire their down payment the day before closing. That way, they have one less responsibility on the day of.

Where does my house down payment go?

The title company acts as a neutral (and insured) third party that holds all of the funds for the purchase and distributes them to the right people.  There are generally several things that need to be paid off before the seller gets paid, this ensures that you are getting the house with a clean title and that no one can come after you, the new home owner, for past debts secured by the house.

Your down payment goes into a title company trust account (aka holding account) with the loaned funds. The title company uses the total funds to pay all lien holders, to settle unpaid property taxes (which are generally payed in arrears), to cover water transfer fees, to pay for title insurance, closing services, agent commissions, and to pay off anything else that has been negotiated to be paid out of the closing proceeds. Once everyone has been paid, the seller gets what is left.

Technically, the closing does not have to be carried out by a title company- a real estate broker can do it- but they would have to be some kind of maniac to take on that level of responsibility and liability when it can be outsourced for less than $200 per party. Using a title company is to the benefit of all involved. They are impartial, they are insured, and this is what they do. Just ranting because, as you can imagine, the question has come up. Coloradans, God love ’em, are a do-it-yourself people.

Is my house down payment tax deductible?

You cannot deduct any amount paid that reduces the principal amount owed on your loan. Since 100% of the down payment goes towards the purchase (and would otherwise be additional loan principal), it is not tax-deductible.

However, mortgage interest on your primary residence is tax deductible. Since the majority of your loan payments in the first few years are paying off interest, this is a huge benefit to owning rather than renting.

For example, if you pay $2000 each month in rent, you spend $24,000 each year on rent and other than having a place to crash, you have nothing to show for it. However, if you are spending that $2000 on a mortgage payment each month and 90% of that payment is interest, you will have a tax savings of up to $7000! Every $7000 counts. 

Can I get a loan for my house down payment?

In most cases, this is not an option, and even when it is, using a loan to pay for your down payment can undermine the quality, and quantity, of loan available to you. All that said, there are lots of personal loan programs for house down payments advertised online. Borrower beware. Don’t take on extra debt right before you want to get a mortgage without discussing the ramifications with your lender.

One pretty common exception is if you already own a home that you can leverage for down payment. This will still affect your debt to income ratio, so don’t go HELOC (Home Equity Line of Credit) shopping before discussing all of your options with your lender. (There are also bridge loan options out there, this is a topic for another post on another day.)

Still trying to decide who your best lender options are? Drop us a line, we are happy to provide you with some referrals, no matter who your agent is. (Just remember us next time you move, pretty please?)

What is the average house down payment amount?

According to a 2019 National Association of Realtors study, the average down payment on a house or condo is 12%; it’s 6% when looking at first time homebuyers only.

6% of the average home price ($500,000!) is still a hefty amount ($30,000!). Fear not, there are still lots of great options in the Denver area for less than $500k. 

Is my down payment home equity?

Yep! How cool is that?

Home equity, since you’re asking, is the value of the property minus the amount you owe.

So, if you buy a home for $350,000 and you put down 6% ($21,000), then on closing day (assuming that the house appraised at the contract price) your home equity is $21,000.

Now, this is where things get interesting.

Let’s say the value of your $350,000 house goes up 3% for 3 years in a row… that would mean… hmmm… let’s math this out (see table below)…

you have turned $21,000 into $68,575.45 by simply owning a home and paying your monthly bills for 3 years.

Pretty amazing. I mean, you’re paying rent otherwise, right? And they said alchemy wasn’t a real thing…

Time owned	market value	loan amount*	your equity (market value -minus- loan amount)	% equity in your home
1 day	$350,000.00	$329,000.00	$21,000.00	6.00%
1 year: 3% value increase over previous year**	$360,500.00	$323,963.00	$36,537.00	10.14%
2 years: 3% value increase over previous year	$371,315.00	$319,053.00	$52,262.00	14.07%
3 years: 3% value increase over previous year	$382,454.45	$313,879.00	$68,575.45	17.93%

*Loan payoff schedule was calculated using this Amortization Schedule Calculator

**the 3% value increase was chosen arbitrarily but it is a conservative estimate when looking at recent years of Denver market data.

Can my parents (/grandparents/aunts and uncles/other family members/incredibly generous friends) make my down payment?

Yes! This is how a lot of people are able to buy their first home. There are some things to consider when handling a gift like this so that it does not interfere with your final loan approval. So, this is another one of those things that you will want to discuss with your lender ***before*** mom and dad cut you a check. 

Maybe your friends and family are not in the position to gift or lend you some or all of your down payment. That’s nothing to be ashamed of. It is still a wise pursuit for you to work towards owning your own home. The equity that you build over time will open up possibilities for you that you haven’t even thought of yet. Rents continue to go up, unfortunately, and as long as housing is treated as a commodity, you owe it to yourself  to get your toe in the door of home ownership. There are programs and options out there, such as the Metro Mortgage Assistance Program and CHFA loans that offer down payment assistance to qualified borrowers. This is within reach. You got this!

Can I use my 401k for my down payment?

Again, yes. Again, talk to your lender. But also talk to your accountant about this one because there are TAX IMPLICATIONS and PENALTIES.

How do most people save their down payment?

This question is what inspired me to write this blog post in the first place. Most people won’t announce to the world where their down payment came from, we live in a society that frowns upon money talk. This leaves some of us at a disadvantage because we are left struggling to figure out how this stuff works.

Well, I don’t usually like to quote Zillow but they have access to a lot of interesting data and survey possibilities so… I’m not going to *not* read their reports. According to their 2018 Consumer Housing Trends Report, this is how home buyers came up with their down payment to buy:

• 70% used at least some savings (only 70%? That’s kind of crazy.)
• 39.1% used money from the sale of a previous house (you read that equity section above, right? If so, this will make sense.)
• 30.1% used a monetary gift from family or a friend
• 26.3% used earnings from investments or stocks
• 26.4% used a loan from a family member or friend
• 26.7% used retirement savings

So, add it all up and you get 218%, right? No, silly! The point is, for most purchases, the down payment is assembled from multiple sources.

Hopefully this article answered all of your burning questions about down payments. If you would like to receive more content like this, sign up for our newsletter.

Got any remaining questions? Contact us, we are happy to help.

Wanna buy a house? We can help with that too. (It’s what we do.)