Real Estate Term of the Day: Down Payment
DOWN PAYMENT – the amount one pays for property in addition to the debt incurred (Barron’s Dictionary of Real Estate Terms)
The main purpose of a down payment is to ensure that the lending institution can recover the balance due on the loan in the event that the borrower defaults. In real estate, the asset is used as collateral in order to secure the loan against default. If the borrower fails to repay the loan, the lender is legally entitled to sell the asset and retain a portion of the proceeds sufficient to cover the remaining balance on the loan, including fees and interest added. A down payment in this case reduces the lender’s risk to less than the value of the collateral, making it more likely that the lender will recover the full amount in the event of default.
Down payment amounts required by loan type:
- Federal Housing Administration (FHA) – minimum 3.5% of the purchase price
- Conventional Loan – minimum 5.0% of the purchase price
- Department of Veterans Affairs (VA) – no downpayment is required
6 Simple Steps to Save for a Down Payment:
- Set up a savings account specifically for your down payment. Don’t allow yourself to use this money for any reason unless absolutely necessary.
- Create a budget & look for ways to save $$$. This could mean cutting out extra entertainment expenses (such as: eating out, going to the movies, going to sporting events), shopping, etc. Use more coupons to cut down on grocery expenses.
- Set up an automatic transfer. From your checking account to your down payment savings account every time you get paid.
- Figure out how much money you need for a down payment. Speaking with a lender to help you understand the ball park amount that you need for a down payment will help you set up your savings goal.
- Set a target purchase date. Even if it is 3 years from now, it will help you set your monthly savings goal.
- Save your tax refund. Don’t spend your tax refund on things you don’t need, try to instead put that money in your down payment savings account. This will help you reach your savings goal faster.
For example, Leslie is currently a renter, but is tired of wasting money on rent. She decides to set a goal to purchase a place of her own when her lease expires in 18 months. After speaking with her local lender, she is qualified to purchase a $250,000 home, only if she can save the down payment necessary. The amount of down payment funds Leslie will need is about $8,800. After analyzing her budget she quickly realizes that if she cuts her daily Starbucks latte habit (costing her $3.50/day), she will save almost $25/week. Using her budget spreadsheet that she created, she has also found a way to save an extra $250/month and sets up an automatic deposit from her checking account to her down payment savings account (a total of $350/month). After filing her taxes, she finds out that a $2,500 tax refund check will be sent to her and decides that the tax refund money will be directly deposited in her down payment savings account, so she isn’t tempted to spend it on frivolous things. After 18 months of saving, Leslie is finally able to purchase a home of her own!
If you have any mortgage questions feel free to call Tonnie Gillen (303-996-8821 direct or via email email@example.com) with Pinnacle Mortgage Group. Tonnie is a local lender that I have worked with over the past several years and highly recommend. She has a proven track record with me of great service and highly competitive rates.
See also: EARNEST MONEY