Everything you need to know about the down payment

Hank Bailey
Hank Bailey
Published on July 15, 2019

Unless your savings account at your local bank is bulging at the seams, you’ll likely need to borrow money to buy a home. Yet, you’ll still need some cash (for the down payment and any closing costs the seller doesn’t cover), so don’t stop socking money away just yet! You’ll need cash to close, which would include your down payment, escrows or prepaids, and closing costs.

I’d like to share some of the questions I most frequently field related to down payments!

Why do I have to make a down payment?

Not all home loans require a down payment, but most do. There are several reasons that many loans do require a down payment. Primary among them is that the money helps protect the lender in case you default on the loan.

Lenders understand that borrowers with “skin in the game” are more apt to do whatever it takes to hang on to the home and not allow the loan to go into foreclosure.

Is the down payment the same as earnest money?

Yes and no. The purpose of the earnest money is to show the seller that you are serious about buying the home. The amount of earnest money varies and it is typically held in a broker’s trust account or in escrow until either the purchase is finalized or you back out of the transaction.

The purchase contract, in a real estate transaction, contains what we call “contingencies.” For example, your purchase may be contingent upon you obtaining final loan approval. Also, the home sale should be contingent upon the home appraising for contract price.  Should either of these not come to fruition, you can walk away from the purchase with a full refund of your earnest money deposit.

If, on the other hand, you get cold feet and walk away from the deal after all your contingencies have been met, your earnest money may be forfeit to the seller.

It is true however that when the purchase is finalized at the closing table, the earnest money deposit is credited toward your down payment or closing costs as needed to reconcile the numbers. So in fact it may become part of your down payment or cash to close.

I’ve heard that some sellers help pay the down payment. Is that true?

No, that is not true. Sellers cannot help the buyer with the down payment. On the other hand, they are allowed to contribute toward the buyer’s closing costs. They call these seller concessions in your purchase contract. Depending on your loan, these can be limited, but typically most loans allow the seller to cover pretty much all of your closing costs as a buyer.

Also, you can use “gift” funds, as long as the money doesn’t come from someone directly involved in the transaction. Be aware though that the person who gifts you the funds must be able to document for your lender where the money came from. Generally speaking, most lenders require that the party making the gift has to be a family member of the borrower.

Otherwise you have to provide documentation that the giftor has a long standing relationship with the buyer.

If the gift funds are undocumented, you’ll need to have them in your bank account for at least 60 days before the lender will consider them “seasoned.” In fact, even your own down payment funds must either be sourced or seasoned, so if you need to move money around, do it as soon as possible.

Can I use money from my retirement account to pay the down payment?

Yes, you can, but I’d encourage you to speak with your financial advisor or accountant before doing so. There may be penalties or tax ramifications that you should consider.

You’ll find information on borrowing money from your 401k at smartasset.com and moneycrashers.com. You’ll also find an article about why it isn’t a good idea to withdraw retirement funds for a down payment at kiplinger.com.

Again, I’d would encourage you to speak with a financial advisor before making the decision. I would also encourage you to speak to your mortgage lender before doing a loan from your 401k.  Why? Well the reason why “Aunt Jenny” can cut you a check for $40k towards your down payment is because your mortgage lender looks at that as a gift.  By pulling money out of a 401k you create another “loan.” This requires a payback, and believe it or not, your lender will have to make sure the creation of this loan will not negatively impact your debt to income ratios where you won’t qualify for your loan.

How much will I need for a down payment?

How much you’ll need for a down payment depends on the loan product you’re using. The U.S. Department of Veterans Affairs and U.S. Department of Agriculture loan programs require no down payment but each has specific eligibility requirements. These are VA and USDA-RD loans.

Other loan programs, such as those offered through FHA and Fannie Mae and Freddie Mac offer low down payments and the range is generally tied to credit scores. With a conventional loan, you’ll typically be expected to pay 20 percent of the loan amount for the down payment, yet there are conventional loans in the marketplace with as little as a 3% down payment too!

You might want to discuss with your lender the benefits though of paying a larger down payment, if it’s within your budget. The more you pay, the smaller the loan amount will be, and the smaller your monthly loan payment! Plus, you very likely will receive a lower interest rate because you are starting out with more equity in the home!

Also, by making a down payment of 20% in the home and you won’t be required to purchase private mortgage insurance, which adds a hefty premium to your monthly house payment.

When is the down payment due?

While you will need to show the lender proof of funds for the down payment, the actual down payment isn’t due until closing.

Initially, the lender will send you a form, called the “Loan Estimate.” While it breaks down all of the costs associated with the loan, pay special attention to the “Costs at Closing” section, specifically the second line under that heading, “Estimated Cash to Close.”

You’ll find a sample Loan Estimate online at consumerfinance.gov.

This amount reflects how much you’ll need to provide at closing before the transaction is funded and closed. It includes the down payment and closing costs, and for example in Georgia, funds in excess of $5,000 are to be wired to the closing attorney’s escrow account prior to closing. If your cash to close is less than $5,000 you may bring a cashier’s check.

Please never hesitate to reach out to us if you have additional down payment questions or to clear up any confusion on other real estate-related topics. We’re always happy to help.

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