Your Down Payment Explained

Background

A down payment is the personal cash contribution that a borrower makes in a purchase transaction. While programs exist for down payments as low as 3% for one-unit primary residences (0% for active US military and veterans), the best loan terms available for one-unit primary residences come with down payments of at least 20%.  If a borrower is to put less than 20% down, lenders will require that the borrower secure subordinate financing or private mortgage insurance.

For other Occupancy Types (i.e. second homes and investment properties) the down payment required to be eligible for financing may exceed 20%, depending on the number of units and product type.

What You Need to Know

Mortgage Insurance

Lenders will require that borrowers secure mortgage insurance with down payments less than 20% for one-unit primary residences. This insurance protects the lender in the event of a loan default and can be paid upfront or in monthly installments. There are also options whereby the lender will pay the mortgage insurance premium on behalf of the borrower, however this will result in a higher interest rate on the loan.

Subordinate Financing

For down payments of less than 20%, borrowers can avoid mortgage insurance by combining a first mortgage with a second mortgage (aka subordinate financing). In some instances, this may result in better terms than mortgage insurance. A common structure for subordinate financing is the 80-10-10, where the “80” refers to the percentage of funds provided by the first mortgage, the first “10” refers to the percentage of funds provided by the second mortgage and the final “10” refers to the borrower’s down payment.

The second mortgage or subordinate financing typically consists of a variable rate home equity line of credit (HELOC) or a fixed rate loan. The rate on the second mortgage is higher than the rate on the first mortgage to compensate the subordinate lender for the additional risk associated with a smaller down payment.

Borrower’s Own Funds

Certain lenders may require that a borrower contribute at least some of their own funds as the down payment instead of getting the entire amount in the form of a gift from a relative. Loans that meet Fannie Mae guidelines with a down payment gift of 20% or more do not require a minimum borrower contribution.